6
CONSUMPTION
When I visit China today, I wonder whether this was how the California gold rush felt in the middle of the nineteenth century. There are lots of unknowns, lots of uncertainty, plenty of risk and occasionally even physical danger. The rules of the game are not entirely clear. But everyone can see the potential and everyone wants in. The discovery of gold in California persuaded many nineteenth-century Americans to pack up and heed the popular calls to “Go west, young man.” In the early twenty-first century, those in search of opportunity must look east to Asia and south to Latin America and Africa.
The rising levels of consumption in the BRIC countries are a compelling sign of how quickly these economies are changing. Consumption and foreign direct investment are the components of GDP that I follow most closely. They tell me how a country is maturing, how much wealthier its people are becoming, what they are choosing to buy and to what extent their economy is opening up to the world. Fast-growing domestic consumption in a developing economy is a good predictor of stability and long-term growth. Increased foreign direct investment indicates how credible the world finds that growth.
There is already plenty of anecdotal evidence of rising BRIC consumption. In summer 2009 my wife and I visited Engelberg, a lovely Swiss resort that could have been the setting for The Sound of Music. Before we left, we had heard that many Bollywood films were shot there, and that as a result it had become a popular destination for Indian tourists. Sure enough, we found Indians on every ski lift going up to take in the mountain views. At the foot of the main lift, there was even a van selling Indian food. Two years later, in spring 2011, we returned to Switzerland, to Les Diablerets, before going on to Lausanne for a luxury goods conference sponsored by the Financial Times. The town was quiet, in between the busy winter skiing and summer hiking seasons. We took a walk to a beautiful spot called Col du Pillon, from where you could take a lift up to 3,000 meters and see the highest Swiss mountains. It was 77 francs for each of us to go up and down. At the then exchange rate, the whole excursion for both of us would cost over $150. We debated whether it was worth the money and decided to go up. Needless to say, it was cold and cloudy at the top and hard to see much, and we came straight back down. But what struck me about the experience was that at the lower entrance to the lift and at the expensive café at the top, Indians surrounded us. Just after I bought tickets for my wife and myself, an Indian gentleman handed over 600 Swiss francs in cash for himself and several friends. At the summit café were maybe a hundred more Indians, spending money and enjoying themselves even though all they could see were clouds.
On our way back down, we saw an advertisement on the lift wall for HSBC Private Bank. It consisted of a picture of a major Chinese city, perhaps Hong Kong or Shanghai, and the claim that HSBC was the best “emerging-market bank” in the world. The story of the increasingly wealthy BRIC consumer had followed me all the way up a Swiss mountain. If, as I suspect, India does see its wealth rise thirtyfold in the next forty years, there won’t just be Swiss cafés and Indian food trucks in these mountains, but proper, top-notch Indian restaurants alongside the traditional European ones. You will be able to ski in or hike up and choose between Rösti and a curry.
In London, the top end of the property market is almost entirely driven by non-British buyers, many from the BRICs. Apartments in South Beach in Miami are now being snapped up by Brazilians. Wealthy Chinese travel and shop in Paris and Tokyo en masse. Russian tourists have been a fixture in the most fashionable European resorts for years now, mooring their yachts in Saint-Tropez or skiing in Courchevel, where they flock for the new year and Russian Orthodox Christmas in the first two weeks of January. They are also expanding their property buying, from London, ski resorts and the south of France to Greece and Turkey. Europe—and potentially the United States—stands to gain from the eventual arrival of millions of BRIC tourists.
The economic evidence of rapid growth in BRIC consumption is at least as compelling as the anecdotes. At the end of 2010, consumption in the BRIC countries came to about $5 trillion. In the United States it was $10.5 trillion, in the European Union $9.5 trillion and in Japan around $3 trillion. Significantly, though, the growth rates in these different markets were dramatically different. In 2000, BRIC consumption was just $1.4 trillion, so the increase to $5 trillion represents an increase of 250 percent over just ten years. If this pattern persists, at least up to the end of this decade, the BRIC consumer markets could be worth $12 trillion or more, easily rivaling the United States.
In a paper written with my colleague Anna Stupnytska in December 2010, I looked at alternative scenarios for BRIC consumption between 2010 and 2025.
1 In the first scenario, we assumed a status quo in which the average share of consumption as a percentage of overall GDP remained the same as it was over the previous decade. Here we found consumption in the BRICs would rise fourfold by 2025, to more than $16 trillion, bigger than the market in the United States. China would be responsible for around half this total, with a real value of close to $10 trillion. India would become the clear second largest, rising to between $3 and $4 trillion.
In an alternative, more optimistic scenario, we assumed that as these economies became more dependent on domestic consumption, and less on exports, for GDP growth, consumer share of GDP would rise. In China, for example, we estimated that the consumer share of GDP would rise to 43 percent by 2015 and 55 percent by 2025. In this scenario, the real value of BRIC consumption would rise fivefold, and China alone could exceed the United States in real terms by 2025. In nominal terms, the Chinese consumer could become worth $20 trillion. The aggregate value of the BRIC consumer would rise each year on average by $2 trillion, taking it to $35 trillion by 2025. Anna and I applied these macroeconomic assumptions for the BRIC consumer to some key specific consumer markets and showed that, if they are correct, the BRIC markets will dominate certain industries, notably cars, luxury goods, travel and tourism.
Both in theory and based on experience, this second scenario is more likely. As happens with energy demand (see Chapter 5), in developing countries we tend to find that rising wealth creates an S-shaped pattern for consumer durable expenditures. The United Kingdom, the United States, Japan and South Korea have all followed these patterns. It takes a while for people to recognize their own wealth and for companies to deliver products they can buy. But once consumer habits are formed and nourished, progress is swift. Applying this model to the BRIC countries, especially China, results in a prediction of extraordinary growth in demand for consumer products. China, by this measure, is around where South Korea was in 1980, on the brink of a significant consumer takeoff.
Applying this approach to the motor industry offers an even richer sense of the scale of the consumer opportunity. By 2050 the Chinese could own twice as many cars as Americans, and India nearly three times as many. Brazilians may own more cars than the combined total in Germany and Japan, and Russians could own more than Germans. Goldman Sachs’ equity analysts predict that in the years up to 2020, most of the growth in the global auto industry will come from the BRICs. By 2020 they reckon that 70 percent of all cars, around 50 million, will be bought in BRIC countries. China could account for half of these. It is not hard to see why the world’s leading motor manufacturers are so focused on these markets. The strong-branded German companies—Daimler, BMW, Audi—are already seeing dramatic growth. A quality German car has become an important status symbol for consumers who would think twice about paying so much for many other things. General Motors, a company that used to symbolize the strength of the United States, has arguably become a company dominated by Chinese business. Suzuki, the Japanese company, is making major inroads into India.
When I talk to auto executives, I find that their concerns about the global economy have changed in the past decade. In the 1990s, they would want to know my views on exchange rates, and whether sharp moves in the dollar, yen or European currencies might hurt their profitability. In recent years they have wanted to hear my projections for the BRICs, and to better understand the risks and opportunities in these markets. For the first time in my career, more of them seem motivated by hope than by fear, and many have smiles on their faces.
Take China: many multinationals first went to the country to take advantage of its cheap labor. They saw a chance to improve profitability through lower costs. But what first brought them into this market is not what is keeping them there. As wages rise, the labor cost advantage of manufacturing in China is eroding. These days, the greatest opportunity is for those companies with the strongest brands. A huge and expanding population now desires and can afford their products. The reality of this came home to me when talking to a colleague in Frankfurt, who wanted to surprise his wife for her birthday by buying her a BMW. When he called his local dealership, he was told he would have to wait six months for the model he wanted, as there was such high demand for it in China. A BMW executive confirmed that this is often the case these days. Not even Germans can buy the BMWs they want when they want them anymore.
Chinese companies have quickly caught on to the importance of brand over cost as a competitive advantage. Every year WPP, a world leader in advertising, conducts a survey to find the world’s top one hundred most valuable brands. Its 2011 listing includes several Chinese companies: China Mobile ranked ninth; ICBC, China’s biggest bank, at eleven; and Baidu, the search engine, at twenty-nine. By 2020 there are bound to be more, perhaps as many as there are American names.
No industry has benefited more from the BRICs’ rise so far than luxury goods. A few years ago I invested in a very small luxury Chinese jewelry company set up by French and Chinese founders. It seemed to me a good bet on the rising prosperity of the Chinese consumer. Chinese consumers will be attracted to many strong global luxury brands, but I also suspected that if there are genuine luxury brands of their own, then they would be likely to prosper too. The company Qeelin has its most successful outlets in the most fashionable shopping malls in Hong Kong and is expanding in Beijing and Shanghai. The Hong Kong store’s biggest customers are generally mainland Chinese tourists. At the time of this writing in mid-2011, a number of bigger luxury goods companies are trying to purchase the company.
My work on exchange rates was rarely of much interest to luxury goods firms, but these days they frequently ask for my thoughts about the world and invite me to attend their conferences. At the 2011 Financial Times luxury goods conference in Lausanne I debated the state of the global economy with the newspaper’s chief economics editor, Martin Wolf, and my ex-colleague Gavyn Davies. We were the opening act ahead of various panels featuring many leading luxury goods brands. It was no surprise to hear most of these companies expressing their great ambitions in the BRIC countries.
One of Goldman Sachs’ luxury goods analysts, Will Hutchings, briefed me for the event. In China, he told me, one in every 1,400 people is a U.S.-dollar millionaire, and there are nearly 200,000 of them in Beijing alone. In the next fifteen years, an additional 500 million–plus people globally will become luxury goods purchasers. About 200 million of them alone will be Chinese. India will be the next biggest-growing purchaser, and both Brazil and Russia will be significant. For many Western companies, maintaining or adjusting their brand to attract these new consumers will be vital, indeed possibly transformational. And it won’t just be about investing more in stores in the major BRIC cities. In fact, foreign “luxury” cities such as Paris, Miami, New York and London will benefit. According to Will, 55 percent of Brazilian luxury goods purchases are made outside Brazil, mainly in Miami, which is to Brazilian luxury shoppers as Hong Kong is to the Chinese. Westerners worried about missing out on the changing pattern of world growth need to be a bit more open-minded. There are many opportunities for Western companies to benefit, especially those with strong brands.
The art market is similarly being transformed by the BRICs. Ed Dolman, the ex-chairman of Christie’s auctioneers, tells me of the shifting demands on his travel schedule, with ever more flights to Beijing, Shanghai and Moscow. In the coming years, I am sure Mumbai will join the list along with other Chinese and Indian cities, as well as Rio and São Paulo. I wouldn’t be surprised to see new auction houses emerging within the BRIC countries.
Many financial market professionals who examine the BRIC story tend to focus on commodities. While it is true that the BRIC countries have a thirst for commodities, a much more significant story lies in how they are starting to behave as consumers. For most of my career, the dominant group in the world economy was U.S. consumers. Everything seemed to revolve around the buying habits of Americans. As the BRIC countries grow, their consumers will become the most important in the world. Chinese people already buy more cars than any other nation, 13.5 million in 2010 to America’s 11.6 million. It could soon be the biggest market for luxury goods. The Chinese government has made increasing domestic consumption one of its economic priorities in the five-year plan laid out in 2011.
Since 2001, the value of BRIC GDP has more than trebled from around $3 trillion to around $12 trillion. Although by the end of 2010 the U.S.-dollar value of the BRIC consumer, $5 trillion, was still less than half that of the United States, the gap will soon narrow. By 2020, the value of the combined level of retail sales in the BRIC countries might be bigger than in the United States.
It is quite simply the story of our generation. It is a reflection of these countries’ dramatically rising wealth, and reflects the desire of their near 3 billion people for the same consumer goods that we all desire in the West.
The key statistic for tracking the growth in demand for consumer goods is GDP per capita, which is rising sharply across the BRICs, but especially in China. Rising GDP concentrated in a few hands does not propel a mass consumer market. But when lots of people are getting richer quicker, it creates a market for millions of new cars, refrigerators, air-conditioning systems, electrical and electronic goods, high-tech gadgets, holidays, luxury goods, financial advice . . . the list never ends. In all of the BRICs, but in China and India especially, the potential increase in wealth by 2050 is fantastic. For producers of consumer products, the potential markets are spectacular.
Western companies understand this. They see it firsthand on their income statements. If you spend any time at BMW’s headquarters in Munich, you end up thinking that what’s going on in China is more important than what’s going on in Germany. Talk to executives at Louis Vuitton or Tesco, and you will soon understand the structural theme driving these companies. Huge new consumer markets are opening up at a rate not seen since the United States emerged as the largest single consumer market in the late nineteenth and early twentieth centuries.
For the major Western economies, the rise of the BRIC consumer should be great news. It means they can stop seeing these countries as low-cost threats, and start to enjoy the profits to be had from selling to BRIC consumers. For multinationals, the BRICs are upending their preexisting business models, for the better.
In mid-2011 Kentucky Fried Chicken already had 3,700 restaurants in China, three times more than its rival McDonald’s, which is much larger in the United States. It has thrived by allowing its Chinese managers the flexibility to adapt their menus to Chinese tastes, leading to fewer chicken wings and more local dishes. Nestlé, Procter & Gamble and Unilever have thriving businesses in China, and in July 2011 Nestlé revealed it is trying to buy Hsu Fu Chi, one of China’s biggest makers of sweets and baked goods, which was valued at the time on the Singapore stock exchange at $2.6 billion. Every week, it seems, I hear another staggering story of changes in Chinese consumption. Japan’s English-language Nikkei Weekly reported in mid-2011 that the average Chinese woman passing through Tokyo’s Narita airport spends $1,000 on cosmetics.
My own employer, Goldman Sachs, stands to benefit if the BRICs’ capital markets develop along with the rest of their economies. Even if policymakers choose to stick with conservative models for financial market development, the potential for significant growth is large. If they choose to pursue “market-based” systems akin to that of the United States, then the potential is enormous. In such circumstances, global financial institutions including investment banks are likely to find great attraction to these markets.
Goldman Sachs has, of course, developed a strategy based around expansion in the BRIC countries. In less than twenty years Goldman could be employing more people in asset management or advisory businesses in Asia than in the rest of the world combined. Either that or many of those employed in those specialties elsewhere in the world will be providing these services to Asian-based clients. Similarly, in Europe, the opportunities that arise in Russia are likely to be quite substantial.
Another important indicator of BRIC consumption is the pace of urbanization. My experience tells me that there is something about urbanization that accelerates growth and increases prosperity. It could be as simple as “keeping up with the Joneses.” People who live in close proximity to others want what they have or more and this stimulates economic competition, which leads to faster growth. Proximity also speeds up the transfer of knowledge. Ideas can be quickly shared and improved upon.
In India, as in China, new cities are sprouting up all over the country. When I worked in foreign exchange, we used to say that you should not have a view on a country’s currency unless you knew the name of its finance minister. These days I tell people that you shouldn’t have a view on China unless you know the names of its most important cities. I once tried learning the name of every Chinese city with more than 5 million people, but quickly had to give up. When the G20 met in Nanjing in 2010, I confess I’d never heard of the place. Yet Jiangsu, its surrounding province, is bigger than Germany. (Incidentally, one of the only European countries to offer direct flights to Nanjing is Germany, an indication of the strengthening ties between them.)
In India, at least fifty cities have a population of more than a million people. So many people living close together, inching up the economic ladder and wanting what so many others have, is a dream for consumer companies. It’s no surprise that executives from fashion, style and leisure industries are swarming through these markets to understand their potential.
In 2005 I served briefly on the board of Manchester United. The evolution of English and world soccer shows the astonishing impact of the BRICs. It used to be that English clubs coveted Brazilian players; now it’s Russian, Asian and Middle Eastern billionaires who scramble to own English clubs.
In 2008 I flew to Mumbai during a European Champions League game in which Manchester United was playing Barcelona. When I arrived at the airport it was halftime. I told my driver to drive as fast as he could to my hotel, and he got there with ten minutes of the game left to play. I asked the receptionist and the porter to take me up to my room as quickly as possible. Once we got there they stood behind me watching the game, as gripped as I was. At the end of the match—we beat them, for once—I sent a message to the then chief executive of the club, David Gill, saying: “Next marketing trick: India.” Who knows, maybe in another ten years United will be fielding soccer teams in China and India.
Shortly before I attended that FT conference in Switzerland, the Chinese Academy of Social Sciences (CASS) forecast that the U.S.-dollar value of Chinese consumption will almost double by 2015, to around $4 trillion. A $2 trillion increase in five years, or $400 billion per year, is the kind of expansion not even the pre-credit-crisis binge U.S. consumer could manage. Postcrisis, it would take the United States somewhere between ten and twenty years to achieve this. To my surprise, when I mentioned the CASS forecast in Lausanne during our panel, the others didn’t seem to think it was such a big deal.
This refusal to accept the importance of what is happening among BRIC consumers is, oddly, not unusual. Many Western commentators struggle to understand and interpret it, and fall back on fear and bias. It is part of a broader pattern of stubborn denial in the face of overwhelming evidence. Some of it is just a simple fear of the unknown. Despite the smiles I find on the faces of executives at multinationals about the rise of the BRICs, it is inevitable that such a major shift in economic power will make people uncomfortable.
Occasionally I hear politicians or investors trying to argue that China is not yet ready to be the world’s biggest economy. That it cannot make the leap from an export-driven economy to one driven by domestic consumption. That it is not ready to assume the global, political role commensurate with its economic muscle. On the first point, I disagree. The assumption that China cannot continue to grow and evolve as an economy seems based on the prejudice that they will forever be old-fashioned, Soviet-style communists. I believe that, by 2013, China could conceivably run a trade deficit, a sign that its dependence on exports is waning. On the second point, the evidence is conflicting.
There will clearly be complications as BRIC consumers soak up ever more consumer goods. My colleague who had to wait six months for a BMW suffered no great hardship. But what if his problem became more widespread and endemic, if increased BRIC demand led to higher prices and forced consumer goods beyond the economic reach of many Western consumers? It is easy to see resentments forming and protectionist attitudes taking hold.
Of course, smart, forward-looking companies will be adapting their brands and cost structures to suit the tastes and aspirations in the new markets, which will be different from the traditional ones. The need for mental as well as procedural adjustment in the so-called industrialized economies will be substantial. Germany in some ways is becoming a role model. Since 2007 German exports to China and India have risen dramatically. As I’ve said, at the current pace, by 2012 German trade with China may outstrip German trade with France. How remarkable is that? In early 2011 Bosch, the German specialist machine parts maker, announced it was boosting employment by more than 30,000 people mainly because of their growth in exports to the emerging world. By the spring of 2011 German employment overall had surpassed its pre-credit-crisis levels, testimony to German manufacturers’ export powers.
I believe that people in developed economies can follow the German model and reap benefits, such as more jobs, from exporting more to the BRICs. But Japan, other European nations and the United States will all have to adjust to profit from the powerful changes under way.
I find myself thinking that BRIC growth and world growth can go hand in hand. Higher growth in one part of the world does not require lower growth in another. Over the past thirty years world GDP growth has averaged around 3.7 percent per year. Between 2000 and 2010 it rose to 4 percent despite the collapse in 2009. As I write this in mid-2011, two and a half years after the global credit crisis, the consensus forecast for world GDP growth in 2011 is 3.9 percent and in 2012 4.1 percent. The BRICs, in my opinion, are driving this higher growth rate around the world—both directly and indirectly.
Many of the Western-based branded goods companies I have discussed are showing very strong earnings growth. The power of the BRIC story can also be seen in the pattern of global consumer spending. While it is difficult for many Western people of my generation to get their minds around this, world shopping is being driven by the emerging world, with the BRICs the most important element.
A major part of the mental readjustment the developed world must undergo involves grasping the difference between wealth and size. Even as the BRICs grow rapidly in the coming years, Europeans and Americans will remain on a per capita basis considerably wealthier. With the possible exception of Russia, no BRIC country will achieve the same wealth as any of the G7 in the foreseeable future. Their gain does not imply our loss. So when Europeans tell me they are worried about competition from the BRICs, I ask them what it is they are really worried about. As I wrote earlier, the aggregate economic size of a country tends to be determined by the size of its working-age population and, crucially, their productivity. Short of enslaving other nations or encouraging mass immigration or somehow fostering an immediate and dramatic increase in birth rates, there is little that national leaders can do about their “size.” If they focus on productivity, however, they can create a greater concentration of wealth among their citizens.
Switzerland does not worry about the growth of France, Germany and Italy. In fact, it wants them to grow, as it means the Swiss can export more and earn more income. The Swiss get richer on a per capita basis as their neighbors get richer. European countries should think about the BRIC countries in the same way, as export markets to be expanded for their own economic benefit.
Where absolute size tends to matter is in determining the role of countries in global institutions and in terms of defense, security and international affairs. In this regard, some of the current G7 members will have competitive issues as the BRICs’ economies become bigger. It is critical that these developed countries don’t hamper change purely because of blind national pride or as a way of preserving jobs in a bloated bureaucracy. Striving for optimal global solutions in areas beyond economics, including such fields as security and the environment, will allow the entire world to thrive and prosper.
If they are to improve the global institutions by properly including the BRICs, the developed countries and G7 members, especially the Europeans, are going to have to give up some of their power. This will require humility and a cold assessment of the facts. Japan and Europe no longer carry the relative weight they once did. The United States may soon have to share superpower status with China. How the established powers choose to accommodate the BRICs into global policymaking will determine whether they win or lose from this irreversible change in the world order.