It is wrong to assume that Chinese tastes are the same as our own and that successful western brands will be able to replicate this achievement in China.

A stalemate ensues until either another person decides to skip the offending drinker (resulting in an uneven contribution) or the recalcitrant party is reminded that it is time they put their hand in their pocket (creating embarrassment). The global economy is in much the same state. We have drained our glasses and are waiting for someone to step in and get the drinking going again.

The consensus opinion is that the next round is on the ‘Chinese consumer’. As a consequence, investors are increasingly focussed on Chinese consumption opportunities, from whisky and chocolate, to aeroplanes and luxury watches.

We are naturally sceptical of ‘no brainer’ investment opportunities and have therefore spent considerable time over the last few months (both in London and on the ground in China) considering whether the Chinese consumer is able and willing to pay for the next round. Before examining the arguments in detail, it is worth reviewing how we reached this uncomfortable moment in the global economy’s ‘night in the pub’.

Lack of global demand

The current crisis can be traced ultimately to a lack of global demand. Trade imbalances created by increasing globalisation have shifted wealth from high consuming import orientated economies (US and UK) to high saving export orientated economies (China and Germany).  

The reluctance of these export orientated countries to consume created deflationary pressures which reduced interest rates which in turn raised asset prices and encouraged debt / asset fuelled consumption in the high spending countries.  

In essence, the US consumer acquired the money to ‘buy their round’ by remortgaging their house.  This came to an abrupt halt when America reached the end of its ability to borrow and asset prices peaked in 2007.

Governments (including China) then stepped in with massive monetary and fiscal stimulus in order to postpone the inevitable hangover.  With the stimulus draining away and (Western) government spending power exhausted, everyone is waiting for the Chinese consumer to put their hand in the pocket. Unfortunately they appear very reluctant to do so.  

Chinese GDP and consumption have grown rapidly in recent years; the latter has failed to keep pace with the former. As a consequence household consumption as a proportion of GDP is falling in China rather than rising. This can be explained by an understandable desire by the Chinese to use newly created spare income to provide for retirement, healthcare and better accommodation.

This situation is clearly recognised by the Chinese government, who appear committed to improving healthcare provision and land rights in an effort to make consumers feel more secure. They hope that this in turn will encourage increased consumption. As a consequence there are some grounds for expecting Chinese people’s desire to consume to increase over time. However, it is impossible to predict when this will happen.

Consumption trends

The second question is whether they are able to take up the slack in consumption. While household expenditure has risen dramatically over the last few years, it is spread across the most populous nation on Earth and equals only US $1,200 per person each year compared to US $30,600 for the equivalent US consumer.  

A huge proportional increase in spending by Chinese consumers is therefore required to offset a small reduction in spending by a US consumer. For example, to compensate for a 5% reduction in spending by the average US consumer requires a 29% increase in spending by the average Chinese consumer.

In addition, this income disparity naturally results in radically different consumption patterns and hence requires different distribution structures which can pose considerable challenges for those companies seeking to profit from the Chinese consumer. A sharp rise in Chinese consumption therefore does not therefore necessarily equate to substantial profits for companies supplying that market.

It is also wrong to assume that Chinese tastes are the same as our own and that successful western brands will be able to replicate this achievement in China. If China becomes the dominant economic power, it is likely that it will drive rather than follow consumption trends. Evidence for this view can be drawn from the history of every global power from Alexander’s Hellenic empire to modern day America.  

Superpowers always exert cultural as well as economic influence. As a consequence, we in the West are more likely to be consumers of Chinese brands over the next few decades than vice versa.
As a consequence, we believe that opportunities to profit from Chinese consumption are therefore less easy to identify and exploit than is generally supposed.  If Chinese do buy the next round, they will undoubtedly choose the drinks.