Are International Managers in China Ready for the New Middle Class?

The service sector is the key to understanding the New Chinese Consumption Model

On Tues I attended a panel discussion at the Asia Society in NY  titled Doing Business in Asia: 2014 and Beyond where five experts shared their thoughts on direction of the business environment in Learn to negotiate in China with China SooveAsia. You can get details and see a webcast here. The 5 experts, including Quartz’s Gwynn Guilford and the Harvard Kennedy School’s Edward Cunningham  laid out their views on the future of Asia with a focus on China.

The five big takeaways:

1. The big story is the growth of the middle class – carrying with it the promise of new prosperity and the threat of greater environmental strains.
2. GDP in China will fall significantly. Although admittedly not economic experts, the panel mostly predicted that China’s economic growth would be somewhere around 5% YOY in the near future — or roughly 30% off official projections. China is shifting from an investment based to consumption based economic model.
3. Pollution will continue to be a major problem.
4. The demand for new health care is rising dramatically.
5. Chinese industry is becoming less competitive as wages rise and the cost of inputs continues to trend upwards. The new middle class is going to be big users and providers of services.

Let’s think about the implications of that last point –the spending shift towards services. Look at the big-ticket service industries: Finance, insurance, transport, media, education, health and entertainment. All heavily regulated – if not owned outright – by the government.

Nothing too earth-shattering there. The panel didn’t challenge the consensus view, but still highlighted some important issues for international managers in China to consider in their strategic planning.

The way I see it, there are 3 basic scenarios for the development of China’s new middle class over the next few years:

1)  The Chinese Dream. Income growth and economic development policies focus on the interior, particularly in the 3rd – 5th tier cities. The big story here is the urbanization of village and farm populations, so much of their spending will be on first apartment, first car and first college tuition. This Chinese middle class is relatively low-income by industrialized standards, but they are doing well — happily spending their income (and subsidies) on locally provided services and a mix of locally made durables and imported accessories. Lots of their income goes to services — some discretionary (media, travel, food-related), some mandated (health, education) and some unseen (supply chain, regulatory, user fees).

This lines up with the Xi administration’s Chinese Dream plan — and with a soft landing / consumption based economy. International businesses have been talking about this for a long time, but these consumers are more Xiaomi than Apple. Western super-luxe branders and mega-market retailers are going to have to up their game if this dream doesn’t turn out to be their nightmare. Not only is this middle class going to pass on expensive imports and famous brands, but they will turn out to be the laboratory – and fuel – for a new class of internationally competitive enterprises.

2) Grumpy intelligentsia heading for the exits. In this scenario, economic gains are sparser and both Chinese and international business leaders do their best to keep the business activity centered in the traditional Tier 1 power centers. There still isn’t enough money to go around in a shifting, slowing economy. The patronage system that served Party elites is concentrating wealth in fewer hands, while pollution, inflation and other lifestyle stresses are all increasing. Shanghai and Beijing look like Bogey’s Casablanca as everyone with the skills and cash searches for a better life and breathable air in the US, Canada and Australia.

This scenario plays to western business strengths in three ways. First, the products and services offered by MNCs are more geared to fussy Tier 1 residents than the hardier stock in the countryside. Second, MNCs already know how to hire, manage and market with Tier 1 types passably well. Sure, they need more carrots since the stick doesn’t work here, but international firms have experience working with big-city managers and yuppie spenders. That’s where advantage number 3 comes in — green cards and overseas posting for middle class Chinese families will become a major bargaining point in the HR office, enabling MNCs to exploit China’s notoriously independent white-collar workforce. No more 18 month job hops when the green card hangs in the balance.

3) Blade Runner with Chinese Characteristics. China’s economy can’t continue to support the traditional Party patronage apparatus with continued brain drain, capital flight, and a shift away from investment-driven GDP cycle. Party elites have to either surrender control of the reigns or find a new way to stay rich and powerful. Guess which one they’ll pick?

Policy barriers to emigration & capital transfer will keep the middle class penned in, and monopoly control on services will fleece them. Chinese yuppies in Shanghai and Shenzhen will earn more than ever, but will be shelling out even faster to pay for all of those service providers we mentioned earlier.

Remember how we said those services were all heavily controlled by the government? The new generation of Party Princelings won’t have too much trouble switching over from being “infrastructure consultants” to “media, education and health services consultants”. It’s already started happening (local SOEs are the majority stakeholders in Shanghai Disney and Oriental DreamWorks). The future of China’s middle-class will be bleak. Off-world visas for those who can pay — a short life of flashy lights and toxic air, food & water for the new middle class.

This will be business as usual for international managers.  Beijing, Shenzhen and possibly Shanghai will require hardship-post pay again (air, cancer), and there will be new emphasis on partnering with service-industry SOEs.

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