Berr China And India Outlook


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An in-depth coverage by BERR, of changing global momentum towards China and India and how UK business can adapt (rather then we wary) of this seismic shift.

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Berr China And India Outlook

  1. 1. BERR ECONOMICS PAPER NO. 5 China and India: Opportunities and Challenges for UK Business FEBRUARY 2009
  2. 2. BERR ECONOMICS PAPER NO. 5 China and India: Opportunities and Challenges for UK Business FEBRUARY 2009
  3. 3. The views within BERR Economics Papers are those of the authors and should not be treated as government policy.
  4. 4. Contents Contents Lists of Figures, Boxes and Tables ii Acknowledgements iv Foreword v Executive Summary vi 1 Introduction 1 2 Opportunities for UK Business 3 2.1 The Growth of China and India 4 2.2 China and India’s Changing Consumer Market 14 2.3 UK Export Performance to China and India 25 2.4 Doing Business in China and India 36 3 Challenges for UK Business 45 3.1 The Growth of Chinese and Indian Exports 46 3.2 Education in India and China 53 3.3 Innovation in India and China 65 3.4 Chinese and Indian Businesses in the Global Economy 80 4 Conclusions 90 References 93 i
  5. 5. List of Tables and Figures List of Figures Figure 2.1: Historical Share of World GDP 4 Figure 2.2: China and India’s GDP 5 Figure 2.3: Projected GDP 6 Figure 2.4: Projected GDP Per Capita 7 Figure 2.5: Distribution of Urban Households by Income Group 13 Figure 2.6: Forecasts of Chinese and Indian Urban Consumption 15 Figure 2.7: Patterns of Urban Consumer Expenditure 16 Figure 2.8: Chinese and Indian Merchandise Imports 26 Figure 2.9: Chinese and Indian Service Imports 28 Figure 2.10: UK Merchandise Trade with China and India 29 Figure 2.11: UK Services Trade with China and India 30 Figure 2.12: Shares of China and India’s Goods Imports 31 Figure 2.13: Contributions to Change in UK’s Exports to China 32 Figure 2.14: Contributions to Change in UK’s Exports to India 34 Figure 2.15: Shares of China and India’s Services Imports 35 Figure 2.16: China and India’s Stocks of Inward FDI 37 Figure 2.17: Problematic Factors for Doing Business in India and China 39 Figure 3.1: Chinese and Indian Goods Exports 46 Figure 3.2: Chinese and Indian Service Exports 48 Figure 3.3: Offshoring Location Preference by Function 49 Figure 3.4: China’s Processing and Non-Processing Exports 51 Figure 3.5: Chinese and Indian Enrolment in Higher Education 54 Figure 3.6: Chinese and Indian Higher Education by Subject 55 Figure 3.7: Comparison of Enrolment Rates in Tertiary Education 56 Figure 3.8: Supply of Skilled Professionals in Selected Countries 59 Figure 3.9: Skills Gaps in Chinese and Indian Workers 60 Figure 3.10: Comparison of Enrolment Rates 65 Figure 3.11: Current Foreign R&D Locations 67 Figure 3.12: Most Attractive Foreign R&D Locations 68 ii
  6. 6. Figure 3.13: R&D in Selected Countries, 2004 69 Figure 3.14: Patenting Trends in India and China 70 Figure 3.15: Regional Distribution of Selected Industries in China 84 Figure 3.16: Chinese and Indian Outward FDI Flows 87 List of Boxes Box 2.1: Changes in Chinese and Indian Government Policy 9 Box 2.2: What is a Middle Class Level of Income? 12 Box 2.3: Case Study - Marks and Spencer 18 Box 2.4: Brand Awareness In China and India 19 Box 2.5: Growth in Car Ownership 21 Box 2.6 China and India’s Regional Towns and Cities 25 Box 2.7: Case Study – JCB 38 Box 2.8: Lessons From Successful SME’s 42 Box 3.1: Vocational Training in China and India 57 Box 3.2: Case Study – Benoy 61 Box 3.3: British Education Institutions in China and India 63 Box 3.4: Case Study – Fiberweb Plc 71 Box 3.5: Case Study – AWI Group 82 Box 3.6: Infrastructure Congestion in Bangalore 86 List of Tables Table 2.1: Estimates of the Size of China and India’s Middle Class 10 Table 2.2: China and India’s Economic Classes 11 Table 2.3: Forecasts of Car Ownership 21 Table 2.4: Ownership of Consumer Durables 23 Table 2.5: Doing Business in India and China 44 Table 3.1: Domestic and Foreign Value-Added in Exports 52 Table 3.2: Estimates of Skilled and Unskilled Workers 56 Table 3.3: Innovation Output in Selected Countries 70 Table 3.4: Key Communication Metrics for Selected Countries 76 Table 3.5: Regional Distribution of Selected Industries in India 83 iii
  7. 7. Acknowledgements The following officials have contributed to this paper: Daniel Mawson, Carol Murray, James Watson, Jenna O’Byrne BERR is also grateful for comments, observations and discussion from a number of academics, businesses and organisations, in particular: Adam Cross Benoy British Chambers of Commerce Bob Lyall CBBC CBI Fiberweb JCB UKIBC iv
  8. 8. Foreword Globalisation has been good for the UK economy. It has created huge benefits, both in lower costing goods of improved variety and greater quality, and larger markets into which UK businesses can sell their goods and services. But as recent events have shown, globalisation also brings with it new challenges and uncertainties. The international financial crisis has demonstrated the need for greater international co-operation to strengthen the global financial system, alongside the shorter term measures we have undertaken in the UK to improve businesses access to finance. But in the longer term, it is the successful incorporation of emerging economies such as China and India which presents the greatest challenge for globalisation. Their rapid economic rise is leading to a re-balancing of economic power around the world, forging new economic linkages through trade and investment flows and changing how businesses see the global economy. The Manufacturing Strategy highlighted the longer run implications for UK business from the growth of these countries, both as potential markets and for the important role they play in global value chains. It emphasised the importance of UK firms investing in the skills and technologies needed to compete with them on quality rather than price. This report examines in more detail the potential opportunities from the rise of India and China, bringing together the latest data and research. Its findings reinforce the message that despite the recent slowdown these two countries represent a tremendous opportunity for UK business, one which successful British firms, both large and small, are already benefiting from. The report also highlights how protectionist fears about the competitive threat from these countries are often overdone. While China and India have continued to develop their skills and innovation capabilities, in many areas a substantial gap remains between them and the UK, which offers a substantial opportunity for UK firms wanting to expand their interactions with these countries. Vicky Pryce Chief Economic Adviser and Director General, Economics Department for Business, Enterprise and Regulatory Reform v
  9. 9. Executive Summary The rise of China and India as major economic powers has been central to the latest phase of globalisation, creating huge opportunities for UK business. However it has also created anxiety about the future of jobs and businesses in the UK. This report seeks to address this by looking at a number of key issues which arise from two broad questions; ●● What are the opportunities for UK business from the growth of China and India as a potential market? ●● What are the challenges for UK business from the rise of China and India as potential competitors? China and India are expected to continue their rapid growth Although they face a number of downside risks, the Chinese and Indian economies are still expected to continue their rapid growth over the next few decades. By 2050 they are forecast to be the first and third largest economies in the world respectively. (Section 2.1) Their rapidly growing middle classes are already a large consumer market in their own right and will account for the bulk of their four fold increase in real consumer spending over the next twenty years. These households aspire to developed country standards of living and demand world class goods and services. Cultural shifts, coupled with rising disposable incomes are driving a shift in the pattern of consumer spending. The share of spending on essentials such as food is declining while the importance of areas such as personal products, private education and healthcare is set to rise significantly. (Section 2.2) Which has helped drive up UK exports On the back of their strong economic growth Chinese and Indian imports of goods and services have risen rapidly. UK firms have been taking advantage of these new opportunities, since 2002 UK exports to India have grown by 14% a year, while exports to China have grown by 19%. The content of UK exports to these countries reflects our competitive advantage in higher skill manufactured goods, as well as financial and business services. However, while the UK has maintained or improved its market share of Chinese and Indian service imports, it has seen its share of their goods imports decline. Analysis of the latest trade data suggests that this has been driven by a decline in UK sector share, rather than a shift in Chinese and Indian import demand away from the types of goods and services we export. (Section 2.3) vi
  10. 10. But doing business in China and India remains challenging In order to take advantage of these opportunities, UK companies must navigate a challenging business environment. The World Bank ranks China and India as the 83rd and 122nd easiest places to do business in the world1, with corruption and bureaucracy still significant issues. Although they are starting to make inroads into the problem, protection of intellectual property rights remains a major issue for UK firms operating in China and India; with the state of enforcement measures lagging behind that of the law. Lessons from successful firms in China and India strongly point towards the importance of taking the long view of the market. Firms need to thoroughly research the market and invest in localising both their products and the people who deliver them. (Section 2.4) Meanwhile China and India’s exports have surged Over the last decade Chinese and Indian exports have risen by 20% a year. China is now the largest exporter of Information and Communication Technology products in the world, while India dominates the market for off-shoring of IT enabled business services. However these impressive trade figures overstate the extent to which China and India have moved up the value chain. For example, over half of China’s exports are from the processing trade, for which the value added of the domestically produced content tends to be small. Once appropriate adjustments are made, the average sophistication of domestically produced goods is found to be low. The data also suggests that Chinese firms are targeting further down the quality ladder than their competitors in the advanced economies. (Section 3.1) But improvements in education and innovation performance need to continue China and India have dramatically expanded their higher education systems which now produce millions of graduates a year, and their spending on R&D has also increased substantially. But in order to fulfil their long run potential both countries need to do more. In education this means building on their graduates technical skills, by ensuring they also develop the broader competencies needed to succeed in the global economy. Their rapid growth has created a huge demand for talent, which already outstrips supply. (Section 3.2) 1 World Bank: Ease of Doing Business Index (2008). For reference the UK is ranked 6th in this survey. vii
  11. 11. China and India: Opportunities and Challenges for UK Business On innovation, while China and India now rank among the top five locations for R&D related FDI, obstacles such as poor IPR protection and access to finance are constraining domestic innovation. (Section 3.3) And challenges to their future growth are emerging The motor behind China and India’s economic rise has been export orientated regional clusters specialising in particular activities. However this model of development is now coming under increasing pressure, particularly in the fastest growing regions. Shortages of skilled labour are generating double digit wage growth, while infrastructure often fails to keep pace with economic growth. Combined with exchange rate appreciation and higher transport costs, China and India’s low cost advantage is being eroded. Although they are optimistic about future prospects, Chinese and Indian businesses see a range of potential constraints on their future growth. This is driving more strategic overseas investments, mergers and acquisitions aimed at securing market access and improving their skills and innovation capabilities. (Section 3.4) Implications for Government policy These findings reinforce the importance of government’s approach to globalisation as both an opportunity and a challenge for the UK. Looking in particular at China and India the main policy lessons are; ●● To continue to resist calls for protectionist measures based on flawed comparisons with China and India. Although large, these countries are still developing and we should engage with them further to reduce the barriers to doing business. ●● Success in China and India requires taking a long term view, developing local connections and expertise. This requires tailored assistance from government to UK firms operating there, which helps mitigate the costs and risks associated with this approach. ●● We need a deeper understanding of China and India’s evolving role in global value chains, how their businesses activities can complement rather than compete with those of UK firms, and how best to use these synergies to compete in the global economy. viii
  12. 12. 1 Introduction “Do not despise the snake for having no horns, for who is to say it will not turn into a Dragon?” The Water Margin Globalisation2 is arguably the most important factor currently shaping the world economy. Although not a recent phenomenon (waves of globalisation can be traced back to the 1800s) the changes it is bringing about now occur far more rapidly, spread more widely and have a much deeper impact than previously was the case. The most recent wave of globalisation has witnessed substantial growth in international trade, capital flows and movements of people. It has been underpinned by three key developments: ●● The adoption of more open economic policies. ●● Technological progress (particularly in the areas of transportation and communication). ●● The integration of rapidly growing emerging economies into the global economic system. The rise of China and India has been central to this story. Spurred on by their own economic reforms, coupled with the increasing fragmentation of global supply chains, these countries have ridden the crest of the latest wave of globalisation. Their growth has helped lift millions out of poverty (an estimated 400m in China alone since 19903), and at the same time consumers in the developed world have benefited from a more diverse range of cheaper goods. However, China and India’s rise has also created considerable anxiety about the future of jobs and businesses in the UK. People see these countries’ huge pools of low cost, but increasingly more skilled labour, and fear that in time they will completely eclipse the UK’s competitive advantage in high skill, high value added products. In this paper we examine the foundations of these concerns in more detail. We look at their progress both in terms of increasing their skill levels and the innovation capabilities of their companies. Although we find evidence of substantial improvements in these areas, China and India still lag behind advanced economies such as the UK. More importantly, China and India also represent a tremendous opportunity for UK businesses as they are the fastest growing markets for the types of high value added goods and services we excel at. A large and rapidly growing middle class has developed in these countries; these households are increasingly 2 Here we define globalisation as “the process through which an increasingly free flow of ideas, people, goods, services and capital leading to the integration of economies and societies” (Köhler 2002). 3 World Bank (2006a). 1
  13. 13. China and India: Opportunities and Challenges for UK Business internationalised, aspire to developed country standards of education and health care, and demand world class goods and services. Structure of the Paper The focus of the paper is on answering two main questions; ●● What are the opportunities for UK business from the growth of China and India as a potential market? ●● What are the challenges for UK business from the rise of China and India as potential competitors? Chapter 2, on opportunities; considers China and India’s historical economic performance and how they are expected to grow in the future. In particular we examine the important role urban middle class consumers will play in shaping consumer demand. This is followed by an analysis of their import demand and the UK’s export performance to these markets. It then examines the challenges faced by firms operating in India and China and how successful UK firms have overcome them. Chapter 3, on challenges; provides a critical evaluation of the evidence on the technological sophistication of Chinese and Indian exports, as well as the extent to which they have improved their skills and innovation capacities. We discuss how the model of export orientated industrial clusters has helped them grow rapidly, but now presents challenges for the global ambitions of their firms in the longer term. Finally Chapter 4 concludes by considering the broader policy implications of this work. 2
  14. 14. 2 Opportunities for UK Business SuMMARy Over the next three decades China and India are projected to become the 1st and 3rd largest economies in the world respectively, but remain relatively poor in terms of per capita incomes. They will also exhibit significant variation in incomes between rural and urban areas, and between fast growing coastal regions and inland areas. Their rapidly growing middle classes are already a large consumer market in their own right and will account for the bulk of their four fold increase in real consumer spending over the next twenty years. These households aspire to developed country standards of living and demand world class goods and services. On the back of their impressive growth performance, China and India’s import demand has risen by an average of 18% a year since 1992. Over the same period UK exports to India have grown by more than 9% a year, while exports to China have grown nearly twice as fast again. The UK has increased its share of Chinese and Indian service imports, but seen its share of their goods imports decline. Investment in China and India has surged as overseas companies seek to take advantage of these huge opportunities. But while substantial reforms have been made, they remain challenging places to do business. Both countries continue to struggle with corruption and bureaucracy and enforcement of Intellectual Property Rights remains poor. Lessons from successful firms in China and India emphasise the importance of taking a long term view of the market; investing in building local connections and developing their people. The UK government has a range of policies in place to help companies seeking to do business in China and India. These range from top level discussions about reducing entry barriers through to more practical advice on how to do business. 3
  15. 15. China and India: Opportunities and Challenges for UK Business 2.1 The Growth of China and India “Poverty is not socialism. To be rich is glorious.” Deng Xiaoping ChINA ANd INdIA hAVE gROwN RAPIdly IN RECENt yEARS The rise of India and China over the last decade should in many respects be viewed as a return to the historical status quo rather than a recent phenomenon. When the ancient European civilisations of Greece and Rome were reaching their heights, the civilisations of China and India were already mature and prosperous. As Figure 2.1 below illustrates, for most of the last two millennia China and India accounted for over half of World GDP between them. However from the 1800s they went through a period of relative decline, with their share of world GDP completely eclipsed by that of the European nations by around 1850.4 Figure 2.1: Historical Share of World GDP 45% Europe China India Japan 40% 35% 30% 25% 20% 15% 10% 5% 0% 1 1000 1500 1600 1700 1820 1900 2003 Source: Maddison (2007) In part these shifts in economic power reflected advances in Europe and elsewhere, however they were also symptomatic of China and India’s disengagement from the world. Some economic historians have argued that having secured an early technological and cultural lead, both countries became complacent and failed to maintain it.5 Regardless, following a lengthy period of general economic stagnation and decline, the reforms initiated by Deng Xiaoping in China in the late 1970s, 4 Maddison (2007). 5 In the case of China for example this is often posed as Joseph Needham’s ‘Grand Question’, more recently India’s period of stagnation has been labelled by Deepak Lal as a ‘high level equilibrium trap’. 4
  16. 16. followed by Narasimha Rao and Manmohan Singh in India in the 1990s; are widely credited with laying the groundwork for them to become the major economic powers they are today. Figure 2.2: China and India’s GDP 2,500 China India 2,000 1,500 1,000 500 0 1980 1985 1990 1995 2000 2005 Source: IMF World Economic Outlook Figure 2.2 shows how China’s resulting growth spurt began in the 1990s, with real GDP growth averaging around 10% a year. Until 2003 India’s growth rate lagged behind, hovering around 6% a year; however since then it has started to pick up, reaching 9.7% in 2006, just short of the government’s goal of 10%. The impact of this on the world economy has been dramatic. Measured at PPP China and India now account for 10.8% and 4.6% of World GDP respectively, compared to 3.3% for the UK. More importantly, their rapid growth is increasingly shaping world demand; accounting for roughly 30% of the growth in world GDP since 2000.6 A key plank of both countries’ reform policies has been a move towards much greater openness to international trade and investment. Starting in the late 1970s, China’s trade with the rest of the world began to rise significantly, with India following suit from the early 1990s onwards.7 ●● Between them China and India accounted for over 10% of the growth in world trade since the 1990s. ●● China’s share of world trade has roughly doubled every ten years. 6 IMF (2008). 7 Source: WTO World Trade Figures. In order to avoid double counting, we consider Hong Kong as separate from mainland China. 5
  17. 17. China and India: Opportunities and Challenges for UK Business ●● India’s trade share remained relatively flat through the 1980s and 1990s, but has started to rise more rapidly over the last decade. ●● This is in the context of world trade growing by 9% a year over the same period. FORECAStS SuggESt thAt thIS gROwth wIll CONtINuE The recent growth of China and India is expected to be continued in the coming decades. Widely quoted work by Goldman Sachs (2003) predicts that China will become the second largest economy in the world by 2016 and go on to overtake the US as the world’s largest economy by 2041. India is not far behind, with its GDP overtaking Japan by 2032. Subsequent refinements to the BRICs model8 have seen these growth projections if anything revised upwards.9 Figure 2.3: Projected GDP GDP Projections ($bn 2003) 50,000 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 00 03 06 09 12 15 18 21 24 27 30 33 36 39 42 45 48 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 China India France Germany Italy Japan UK US Source: Goldman Sachs, Dreaming with the BRICS (2003) Although these countries will become significant in terms of economic size, their per capita incomes will still be low by the standards of the advanced economies10. As Figure 2.4 below illustrates, in 2050 China’s average per capita GDP is forecast to be only slightly higher than the current level in the US, with the figure for India less than half that. 8 BRICs – Brazil, Russia, India, China. 9 See for example Goldman Sachs (2003, 2007, 2008) and PWC (2008). 10 See for example World Bank (2007a, 2008b), PWC (2008). 6
  18. 18. Figure 2.4: Projected GDP Per Capita 100,000 GDP Per Capita ($US 2006) 90,000 2006 2050 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 China India France Germany Italy Japan UK US Source: Goldman Sachs, BRICs and Beyond (2007) These forecasts in part reflect the ambitious plans set out by the Chinese and Indian governments, some of the challenges for which are discussed in Box 2.1. Both countries see themselves as global economic and political players, and increasingly expect their level of recognition and influence in international institutions to reflect this. However, at the same time such projections are best seen as an indication of the potential for growth in India and China if ‘things go right’, rather than a prediction of the future. In practice there are a number of downside risks which need to be borne in mind. In the short term these include; ●● Both countries are being adversely affected by the global downturn brought about by the credit crunch; China in particular is overly reliant on external demand to fuel growth. ●● If the downturn were to lead to an increase in protectionism their export led growth model leaves them vulnerable. ●● They need to rebalance their economies; China towards domestic demand, while India cannot sustain its current rates of growth purely on the back of service sector exports.11 ●● A slowdown or reversal of their reforms would lead to business activity being choked off by factors such as bureaucracy, corruption and lack of access to finance. 11 For example see Panagariya (2007). 7
  19. 19. China and India: Opportunities and Challenges for UK Business The risks in the medium to longer term revolve more around the need for them to move to more sustainable modes of production; ●● They have a shortage of natural resources; China’s per capita stocks of water, arable land and minerals are well below the world average, India is also highly dependent on imports of raw materials, in particular petroleum and related products.12 ●● China’s production methods are environmentally unsustainable, with a high energy intensity of GDP and pollution discharges per unit of output13. India performs better in this regard, but its manufacturing sector is only now entering a high growth phase.14 ●● Their advantage as low cost production centres is being eroded by rising wage costs due to shortages of skilled labour in fast growing regions. (See Chapter 3). ●● In order to prevent social unrest their governments need to spread the benefits of growth more widely. (See Box 2.1) 12 Kai, M (2004). 13 See Junko Z. et al (2005). 14 For example India’s Energy Intensity of GDP is estimated to have been 142.4 tonnes of oil equivalent per $m (real 2000), compared to 195.1 in China. 8
  20. 20. BOx 2.1: ChANgES IN ChINESE ANd INdIAN gOVERNMENt POlICy The first wave of economic reforms in China and India were focused on fostering enterprise and export led growth. Current policies aim to build on this, while delivering more balanced economic development through: ●● Continued reform of the state sector. ●● Protection for vulnerable groups. ●● Reduction of regional income disparities. In China this is driven by the need to address the negative consequences of its breakneck economic growth. The policies of the last thirty years which encouraged un-restrained growth, widening income disparities and environmental degradation; are now regarded as unsustainable. Under the banner of ‘creation of harmonious society’ the government is now trying to tackle these problems, while also attempting to spread the benefits of growth more widely. Through a combination of infrastructure investment and incentives for firms to relocate, the government hopes to stimulate more economic activity in China’s inland regions. In India the Common Minimum Programme (CMP) is intended to address a wide range of development issues; whilst also reconciling the competing demands of the electorate and strong cultural opposition to market reforms such as the privatization programme.15 The government has also announced its intention to develop a stronger, more labour intensive export-orientated manufacturing base. To this end FDI will be encouraged in infrastructure, technology intensive manufacturing and export orientated production. Especially where ‘local assets and employment are created on a significant scale’. In terms of international policy, both countries aspire to regional economic leadership. China has committed to signing free trade agreements with the ASEAN countries by 2015, while India has attempted to position itself as a leader of developing nations in multilateral forums such as the WTO. 15 15 The government aims to privatise the state run sector within ten years, with some official estimates suggesting that 60% – 70% of the programme will be complete by 2013. Foreign investors are permitted to bid for these assets and in principle enjoy equal treatment in matters such as business licensing. 9
  21. 21. China and India: Opportunities and Challenges for UK Business Leading to a rapidly growing urban middle class Although per capita incomes will remain relatively low in China and India, this masks huge variation between different regions as well as rural and urban areas. Cities in their fastest growing regions already have a large population of more affluent middle class households. A number of studies have attempted to forecast the size of the global middle class, but few break down their estimates by country. A summary of the findings of the small number of studies which do so for China and India is given in Table 2.1 below. Table 2.1: Estimates of the Size of China and India’s Middle Class China and India’s Middle Class Population China India Source Estimate (year) Source Estimate (year) goldman Sachs ~1bn (2030) goldman Sachs ~1½bn (2040) McKinsey 612m (2025) McKinsey 384m (2025) uBS 20m-70m (2007) world Bank 56m (2000)-361m (2030) world Bank up to 57m (2030) Source: Bussolo et al (2007), Goldman Sachs (2008), McKinsey (2006, 2007), UBS (2007) The World Bank estimate that the proportion of the world’s population who are middle class will roughly double between 2000 and 2030 (from 7.6% to 16.1%). High rates of growth in developing countries means that they are expected to make the biggest contribution to this shift.16 Thus by 2030 an estimated 1.2bn people in developing countries (15% of the world population) will be middle class17. China and India dominate this trend, by 2030 they could account for as much as 44% of the global middle class; ●● Chinese citizens accounted for 13.5% of the global middle class (in 2000, by 2030 this is expected to increase to 38%. ●● By 2030 India’s share of the global middle class population is forecast to rise to 6%.18 ●● China’s income distribution is expected to shift with middle income cohorts making up a larger share of the population.19 16 Population growth rates of households within the middle class are 18% compared to a world average of 32%. All other things being equal this implies that more households are moving into the middle class group, rather than households within this group growing in size. 17 These are taken from Bussolo et al (2007), who use Milanovic and Yizhaki’s values for middle class income. 18 Bussolo et al (2007) where unable to estimate the current size of the Indian middle class due to limitations in the Indian Household Survey. 19 Although India will experience growth rates in per capita incomes above world average, the differential is not large enough to make this country significantly move along the global income distribution. 10
  22. 22. Studies by McKinsey (2006, 2007) and Goldman Sachs (2008) are substantially more optimistic. The latter forecast that by 2030 the size of the global middle class could reach 2bn people. By 2020 they expect 70% of the Chinese population to be middle class and similarly by 2040 the vast majority of Indians will be in this group. In part this is because the definitions of middle class income used in these studies can vary significantly (See Box 2.2). For our purposes we make use of the income bands used by McKinsey (2006, 2007). These are based on values employed in surveys of household expenditure in India and China, such as that carried out by NCAER (2004, 2008). These are then converted into $US equivalents at a fixed exchange rate.20 Table 2.2: China and India’s Economic Classes China and India’s Economic Classes (Real Annual household Incomes) China India Renminbi $uS Rupees $uS global >200,000 >24,155 global >1,00,000 >21,882 Affluent 100,000-200,000 12,077-24,155 Strivers 500,000-1,00,000 10,941-21,882 upper Aspirants 40,000-100,000 4,831-12,077 Seekers 200,000-500,000 4,376-10,491 lower Aspirants 25,000-40,000 3,019-4,831 Aspirers 90,000-200,000 1,969-4,376 Poor <25,000 <3,019 deprived <90,000 1,969 ‘Middle Class’ 25,000-100,000 3,019-12,077 ‘Middle Class’ 200,000-1,000,000 4,376-10,491 Source: McKinsey (2006, 2007) – All prices are in real 2000 terms On the face of it an annual household income of between $4,000 and $20,000 would not provide a particularly affluent lifestyle in most developed countries. However such measures do not adjust for differences in purchasing power. Converted at PPP our middle class income band in China becomes $13,500 – $53,000 whilst the equivalent figures for India are $23,000 – $118,000; which purchases a more recognisably middle-class lifestyle. Although defensible in terms of thinking about standards of living, definitions based on PPP values carry with them an important caveat. Whilst a household in China or India which earns $50,000 a year measured on a PPP basis might aspire to a developed country standard of living; from the perspective of overseas firm trying to sell into these markets, what matters is their purchasing power measured at market exchange rates, which is much lower.21 20 McKinsey use the prevailing exchange rates in 2000. These are 8.28 RMB to the Dollar at market rates/1.85 TMB to the Dollar at PPP for China and 45.7 Rupees to the Dollar at market rates/8.5 Rupees to the Dollar at PPP for India. 21 A counterpoint to this is of course that given domestically produced goods and services may be much cheaper, this could leave more disposable income available for more expensive international brands. Also by shifting production into these countries companies will also be able to reduce their costs. 11
  23. 23. China and India: Opportunities and Challenges for UK Business BOx 2.2: whAt IS A MIddlE ClASS lEVEl OF INCOME? A number of attempts have been made to define what constitutes a middle class level of income. Early studies often made use of relative measures, linking it to some function of the income distribution22. However when thinking about consumer demand such definitions are less useful as they do not allow easy comparison across countries. Milanovic and Yitzhaki (2002) proposed disaggregating the world population into three categories; poor, middle class and rich. The average real per-capita incomes of Italy and Brazil in 2000 measured at purchasing power parity (PPP) were used as the upper and lower bounds respectively for the middle class group. Using these figures, a middle class per capita income would lie between $4,000 and $17,000 implying an annual household income of between $16,800 and $72,000. On this basis many people in the OECD countries would be classified as rich, whilst the ‘relatively rich’ in many developing countries would be considered middle class. The advantage of this approach however is that these bounds are defined in terms of real purchasing power and hence do not need to be revised in line with rising incomes over time.23 Goldman Sachs (2008) proposed a lower range of $6,000-$30,000 per capita measured at PPP. An even lower bound was used by Duflo and Banerjee (2007) who defined the middle class as those earning $2 – $10 per day measured at PPP (roughly $800-$3,600 a year). An alternative approach employed by UBS (2007) is to define the middle class on the basis of a level of income which is high enough to sustain above average spending on luxury items. Or by Chinese standards. “...a decent flat, a car, nice appliances and an entertainment budget”. Drawing on cost of living data they estimate that an urban household in China would need to be earning in excess of $10,000 – $18,000 a year ($3,300 – $6,000 per capita) to sustain a middle class or better lifestyle. Given these income bands McKinsey provide a breakdown of their forecasts of China and India’s urban middle classes by income group. Although the brackets they use are not identical, they are sufficiently comparable in Dollar terms to draw broad conclusions about the balance rich, middle class and poor households.2223 From Figure 2.5 we can see that in 2005 the urban populations of India and China were predominantly from lower income groups. China in particular has a much higher proportion of households living on poor/deprived levels of income. By 2025 these will have largely been supplanted by upper-aspirant/seeker households who will account for over half the urban population. 22 For example, see Easterly (2001) or Birdsall, Graham and Pettinato (2000). 23 World Bank (2007a) Global Economic Prospects. 12
  24. 24. Figure 2.5: Distribution of Urban Households by Income Group China India 100% 100% 90% 90% 80% 80% 70% 70% 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% 2005 2025 2005 2025 Global Global Affluent Strivers Upper-Aspirant Seekers Lower-Aspirant Aspirers Poor Deprived Source: McKinsey (2006, 2007) However, whereas in China the top two income groups are expected to account for less than 10% of the urban population in 2025, in India they will be nearly a third. By 2025 while China may have a much larger urban middle class than India overall, the latter could have more highly affluent households, both in absolute and relative terms.24 Underlying all of these forecasts is a story of large scale rural-urban migration coupled with urban incomes growing more rapidly than the economy as a whole. The consequence of this is that although they account for less than half of China and India’s populations, expenditure by urban households will dominate consumer spending. We now turn to the implications of this in more detail in Section 2.2 below. 24 In terms of the very highest income group, Merrill Lynch, Cap Gemini (2007) estimated that there were 100,000 High Net Worth Individuals (HNWI) in India in 2006, compared to 345,000 in China, but that this group has been growing more rapidly in India than in China. By comparison there were 485,000 HNWI’s in the UK in 2006. 13
  25. 25. China and India: Opportunities and Challenges for UK Business 2.2 China and India’s Changing Consumer Market “When the Goddess of Wealth comes to give you a blessing, you should not go to wash your face” Indian Proverb uRBAN CONSuMPtION IS FORECASt tO RISE SIgNIFICANtly China and India’s (predominantly urban) middle class populations are expected to expand significantly. The combination of rising incomes and expanding urban populations will lead to a dramatic increase in their spending power over the next twenty years. However, whether this will translate into a similarly large increase in consumption is dependent on factors such as savings behaviour and levels of social protection. Limited state provision of health and pensions and undeveloped financial markets has historically led to high savings rates in China and India. In 2005 China’s national savings have been estimated to be over half of GDP, whilst India’s were nearly a third (compared with a quarter in Japan and an eighth in the US). For China, the generation born just prior to the introduction of the ‘one child’ policy in 1979 is now at prime working age, helping to push up average household incomes. However, over the next 20 years China’s demographics will start to work against it.25 ●● Population growth to slow to zero by 2030 and thereafter become negative. ●● The share of the population aged 65 and over will more than double from 7.7% in 2005, to 16.2% over the same period. ●● With birth rates relatively stable, this will lead to a rising dependency ratio.26 India’s demographics are much more favourable. Falling birth rates and changes in life expectancy mean that the share of the population aged 15-65 is expected to rise until 2040, falling slightly thereafter. ●● Population growth to slow to below 1% by 2020, but remain positive for the foreseeable future. ●● The share of the population aged 65 and over will increase to 10% by 2035. ●● The growing adult population will help drive down the dependency ratio.27 In India the falling dependency ratio will reduce the pressure to save for old age, freeing up more income for consumption amongst its youthful population. China’s increasing life expectancy will initially drive up savings rates, but as 25 These forecasts are drawn from UN population database. 26 The dependency ratio is defined as the proportion of the population who are too old (aged above 64) or too young (aged under 15) to work. 27 India’s old age dependency will rise slowly, but this is more than offset by a falling child dependency ratio. 14
  26. 26. its population ages this should help to reduce savings as they run down their savings during retirement.28 Coupled with improvements in their financial sectors, these trends mean that changes in savings behaviour are expected to have a positive or at least neutral effect on spending. McKinsey forecast aggregate consumption to more than quadruple in real terms by 2025 – to $3,265bn in China and $1,521bn in India29. If realised, China and India will become the third and fifth largest consumer markets in the world respectively. In China the majority (64%) of urban consumption will come from the upper- aspirant group, roughly in line with their share of households. In India, despite accounting for only a third of urban households, the top two income groups (globals and strivers) will be responsible for 59% of spending. As we can also see from Figure 2.6, India’s rapid expansion in consumer spending is expected to lag China’s by up to a decade. Figure 2.6: Forecasts of Chinese and Indian Urban Consumption China India Real Urban Consumption Real Urban Consumption Expenditure (bn Renminbi, 2000) Expenditure (bn Rupees, 2000) 25,000 50,000 20,000 40,000 15,000 30,000 10,000 20,000 5,000 10,000 0 0 2005 2015 2025 2005 2015 2025 Global Global Affluent Strivers Upper-Aspirant Seekers Lower-Aspirant Aspirers Poor Deprived Source: McKinsey (2006, 2007) 28 Life-cycle models of saving predict that savings rates are higher in the working age population as they build up savings for retirement and then fall in old age as the retired population starts to run down their savings. 29 Both figures are in constant 2000 US Dollars converted at market exchange rates. 15
  27. 27. China and India: Opportunities and Challenges for UK Business To some extent these forecasts understate the purchasing power of Chinese and Indian consumers. If we were to convert these figures into Dollar terms using PPP exchange rates this would imply aggregate real consumption expenditure in India and China of $9.2trn and $14.6trn respectively (larger than the US today at $7.8trn).30 PAttERNS OF hOuSEhOld ExPENdItuRE wIll ChANgE Although detailed analysis of consumption trends for the whole of China and India’s populations are not generally available, a number of studies have focused on the key group of urban consumers. Figure 2.7 below provides an illustration of how the breakdown of urban household expenditure in China and India is expected to change. Figure 2.7: Patterns of Urban Consumer Expenditure China India Breakdown of Consumer Spending Breakdown of Consumer Spending 100% 100% 90% 90% 80% 80% 70% 70% 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% 2005 2025 2005 2025 Housing and Utilities Transportation Education Services and Personal Items Communication Health Care Household Items Food and Apparel Source: McKinsey (2006, 2007), Authors Calculations The main driver behind these shifts in spending is that incomes have risen above the threshold level needed for essentials such as food, basic clothing etc. This leaves them free to increase spending on discretionary items such as luxuries, improved health care and education. Cultural and demographic factors have also played their part; the current generation of consumers in China and India are more likely to have a philosophy 30 Although the earlier caveat about conversions using PPP versus market exchange rates still applies. 16
  28. 28. of ‘enjoy life today’ as opposed to their parent’s mentality of ‘save for the future’. We now provide a brief overview of some of the trends driving expenditure in each of the broad product categories: Essentials (Food and Apparel) Although it will decline as a share of household expenditure, spending on essentials will still grow significantly in real terms. Within this we would expect to see; ●● A shift in household spending towards a richer more westernised diet, with increased consumption of meat and dairy products.31 ●● Greater consumption of luxury items such as alcohol and tobacco as well as designer apparel. ●● The impact on world food prices to be moderated by their agricultural policies which are geared towards self sufficiency.32 Services and Personal Items In common with spending on household items, demand for recreational services as well as personal products is forecast to grow more rapidly than overall consumption. ●● In China a shift in attitudes coupled with deliberate government policies (such as the ‘Golden Week’ holidays) all point towards a broad based increase in this category of spending.33 ●● Growth will be even more rapid in India, which already has a large market for personal/household services and a historically large demand for jewellery.34 ●● Although spending on entertainment in India will more than triple by 2025, it does so from a low base and so will remain a small component of the overall total. 31 These trends are already apparent in official figures, for example Chinese urban households doubled their per capita consumption of milk and poultry between 1999 and 2006 (China Statistics Yearbook 2000, 2007). 32 As a result of deliberate government policies China and India are largely self sufficient in staple food products (China’s official target for grain self sufficiency is 95%). However these policies and related price controls are likely to come under increasing pressure as demand rises. 33 ‘Golden Week’ is the name given to a pair of week long national holidays, however due to the disruption they have caused the Chinese government is planning to re-organise them to better distribute them and reduce the pressure on transport infrastructure etc. 34 Jewellery is commonly used as a vehicle for personal savings in India. 17
  29. 29. China and India: Opportunities and Challenges for UK Business BOx 2.3: CASE Study – MARKS ANd SPENCER35 In 2008 Marks and Spencer announced a Joint Venture (JV) with Reliance Retail to open fifty full scale stores in India over the next five years. Although they already had franchise operations there, when the company reviewed the potential scale of the market opportunity in India, it decided to invest more directly. In looking for a JV partner M&S were highly conscious of the need to access capability in three key areas; property, logistics/supply chain and experience of operating in India. A key driver behind their selection of Reliance was the company’s drive and ambition. Management of their Indian operations is shared between the two companies, with functions such as HR and marketing being locally recruited. This was critical to retaining the core values of the brand whilst also being able to personalise their offering to the local market. Although their experience of operating in India has generally been positive, M&S perceive a number of challenges: Lowering pricing whilst maintaining quality is vital to attracting the Indian consumer, infrastructure remains an issue and the time between decision making and delivery is longer than in the UK. M&S is also seeking to expand into the Chinese market, recently opening its first store on the mainland in Shanghai’s premier shopping district. As with its Indian operations the strategy is to build on their reputation for quality and localise the brand without compromising its core values. Household Items35 Changing lifestyles and more leisure time is already leading to increased demand for recreational items such as DVD players, game consoles and satellite TV, in addition; ●● Demographic trends in China will encourage spending growth on items such as furniture and appliances as Chinese households tend to spend more on these products in later life.36 ●● Low product penetration for appliances and entertainment items in India is likely to persist, due to factors such as a lack of infrastructure and relatively low spending on entertainment. ●● This is changing in India’s urban areas, but slower growth in rural areas will hold down overall spending growth in this area.37 35 Source: UKIBC. 36 Young Chinese couples commonly live with their parents whilst they save up enough to allow them to move out into their own home, at which point their spending on such items significantly increases. 37 For example see McKinsey (2008c). 18
  30. 30. BOx 2.4: BRANd AwARENESS IN ChINA ANd INdIA Chinese and Indian consumers are increasingly brand conscious. A walk through the major shopping districts in cities such as Bangalore or Shanghai reveals a huge range of shops dedicated to international brands, particularly luxury products. Although the top global brands can rely on instant recognition thanks to their international reputation, awareness of smaller and more niche brands is much less widespread. These companies have to build up a reputation for quality through word of mouth recommendations, which remain one of the most important marketing mediums. Surveys such as McKinsey (2008c) suggest that achieving this recognition can be extremely important as Chinese and Indian consumers are not only willing to pay a premium for quality (when they recognise it), but also exhibit high levels of brand loyalty. Companies operating in India and China have found that increasing national pride has bolstered the perception of some domestic brands, particularly in regional cities where consumers may not quite have the disposable income to afford a major global brand. Perhaps surprisingly, these same consumers are not always aware of the foreign nature of their favourite products. When surveyed, 67% of Chinese consumers mistook consumer beverages such as Coca-Cola, Pepsi and Sprite to be domestic rather than foreign brands. Although these brands do not hide their foreign origins, their name, packaging and marketing have all been given a specific Chinese identity. Education Education is regarded as a priority by both Chinese and Indian households and already accounts for a relatively large proportion of household expenditure38, however; ●● As China’s population ages and the number of children declines, spending on education will fall as a proportion of household spending even while spending per child is likely to increase. ●● India’s booming youth population will make this one of the fastest growing categories of household expenditure, doubling its share. 38 At 4% and 6% in India and China respectively, education accounts for a much higher proportion of private expenditure than in most advanced economies, which typically spend less than 4% due to their much larger public education systems. BERR (2008) Public Services Industry Review. 19
  31. 31. China and India: Opportunities and Challenges for UK Business Health Care Limited health care infrastructure and greater health awareness has encouraged a large increase in private provision, which will continue as health insurance becomes more prevalent. ●● Private spending on health related goods and services in China and India is expected to reach 13%-14% of household consumption by 2025, substantially higher than in most advanced economies.39 ●● China’s ageing population, coupled with increases in ailments associated with pollution, urbanisation and a richer diet, will combine to make this the fastest growing category of household expenditure. ●● India’s demographics are more favourable, but health spending will grow almost as rapidly. Transportation Affluent Chinese and Indian households are shifting their preferences away from public to private transport (See Box 2.5), as well as more overseas travel.40 ●● Transport already accounts for 17% of Indian household expenditure, but infrastructure bottlenecks will keep growth below its potential. ●● Such constraints are less binding in China, allowing for more rapid growth in spending, although it will remain a less important category of spending than in India. ●● It is unclear though how factors such as rising fuel prices will act as a constraint on spending, as they remain subsidised by government.41 39 Outside of the US, private expenditure on health care is typically around 4% of consumption in the advanced economies. BERR (2008) Public Services Industry Review. 40 National Statistics (2008) estimate that from 2002 the number of visits from Chinese and Indian citizens to the UK grew by 8.5% and 15.7% a year respectively, reaching over half a million visits in 2006. On average these visitors also stayed for longer and spent more while they were here. 41 Due to the widening gap between the world price of crude oil and China’s officially set domestic fuel prices its refineries have been making substantial losses (Sinopec the largest refiner lost £1.5bn in the first quarter of 2008 alone). The government raised its official prices in June 08 by between 17% and 25% the largest increase for four years, but still well below what was needed to close the gap. 20
  32. 32. BOx 2.5: gROwth IN CAR OwNERShIP There is a well documented relationship between car ownership and aggregate per capita incomes. At levels of per capita income below $5,000 car ownership tends to be low, but once this threshold is reached it starts to increase rapidly (with only limited evidence of demand beginning to be satiated at higher income levels). Based on this relationship Chamon et al (2008) predict that car ownership in China will overtake that in the uS by 2030, with India following suit by 2050. As a result their combined share of world car ownership will increase from 4.3% in 2005 to 32.4% in 2050 (though per capita car ownership in the US will still remain substantially higher). Table 2.3: Forecasts of Car Ownership Car Ownership (millions, % world total in brackets) USA India China Advanced Rest of World World Total Economies 2005 153 (24%) 7 (1%) 21 (3%) 304 (47%) 161 (25%) 646 2010 171 (23%) 9 (1%) 51 (7%) 332 (44%) 197 (26%) 760 2020 211 (20%) 19 (2%) 134 (13%) 390 (27%) 292 (28%) 1046 2030 253 (17%) 55 (4%) 255 (17%) 442 (30%) 468 (32%) 1473 2040 295 (14%) 163 (8%) 415 (20%) 490 (23%) 732 (25%) 2095 2050 337 (12%) 367 (13%) 573 (20%) 532 (18%) 1098 (38%) 2907 Source: Chamon et al (2008) Note: Advanced Economies excludes the USA Such a massive increase in car usage will inevitably have an impact on world oil prices which are already under pressure from rapid growth in Chinese and Indian demand. More broadly it will also create major challenges for these countries in terms of managing congestion and pollution, as well as having implications in terms of climate change. 21
  33. 33. China and India: Opportunities and Challenges for UK Business Communication Reforms made in the 1990s have led to a massive expansion of telecommunications in China and it is now the largest mobile phone market in the world. India’s reforms came later; as a result the market is only now entering into a similar rapid growth phase. ●● Telecommunications already account for 8% of Chinese household expenditure, but are still expected to grow faster than overall consumption. ●● Although it only accounts for 2% of Indian household expenditure, the huge potential for expansion means that this will be the fastest growing category of spending, tripling its share by 2025. Housing and Utilities42 Modelling spending on housing and utilities is complicated by a number of methodological problems and the impact of government policies towards housing. That said; ●● The recent privatisation of the housing stock in China has created a huge housing market and ignited demand for home improvements. ●● India’s large rural population and slowing rate of urbanisation means that spending on housing will grow slowly. ●● As a result, while the proportion of spending will shrink in India, it will grow to become the second largest category in China. But the regional dimension should not be overlooked While China and India’s fast growing regions are already attractive consumer markets, they are also becoming intensely competitive. It has been argued that some areas are now oversaturated with domestic and foreign brands and that a wave of consolidation is imminent.43 In response to this international firms are now increasingly looking further afield in China and India; but in doing so they find that they are far from homogenous markets. As we can see from Table 2.4 below, although consumer durables are common in urban households, ownership rates drop off dramatically in rural areas (which make up 60% – 70% of China and India’s population44). 42 In terms of methodology there is the question as how to determine imputed rents on owner occupied property and what the implications are of rising house prices. On the policy side both the Chinese and Indian governments subsidise utilities and housing to some degree or other. 43 See for example Gustavsson (2008). 44 There is considerable debate about official figures for China and India’s rural populations. It has been argued though these figures overstate India’s rural population as they do not fully account for people who live on the periphery of larger urban agglomerations, while China’s population statistics may understate its rural population. For example see McKinsey (2007), Anderson (2006), UBS (2007). 22
  34. 34. Amongst these households, lower disposable incomes and a lack of necessary infrastructure (such as reliable electricity supplies), have so far constrained demand for these types of products. Rural households also face tighter budget constraints which limits their ability to make certain types of routine expenditures. For example, Hindustan Unilever found that rural consumers struggled to afford the relatively large containers of personal products commonly sold in countries like the UK. But, by creating a reusable sachet which could be refilled locally, they created a sales format which allowed consumers to break their purchases down into more affordable lumps, as well as significantly reduce the cost of the product. Table 2.4: Ownership of Consumer Durables durable Consumer goods per 100 households (2006, or most recent year available) China India urban Rural urban Rural total Automobiles 4.3 .. 4 0.7 1.7 Bicycles 117.6 98.4 51.9 57.2 55.7 Cameras 48 3.7 0 0 0 Computers 47.2 0 0 0 .. Microwave Ovens 50.6 .. .. .. .. Motorcycles 20.4 44.6 28.3 7.9 13.6 Refrigerators 91.8 22.5 30.8 4.8 12.1 telephones 93.3 64.1 .. .. .. telephones: Mobile 152.9 62.1 .. .. .. televisions 137.4 89.4 70.4 27.5 39.5 Video disc players 70.2 .. 8.2 1.7 3.6 washing machines 96.8 43 12.5 0.9 4.1 Source: Chamon et al (2008) However, whilst the term ‘rural India and China’ might conjure up visions of small villages dominated by subsistence farming, with poor infrastructure and limited connectivity to the rest of the world, the reality can be quite different. For example, approximately a third of the rural Indian population lives in close proximity to an urban area or in a rural economic centre. These communities have relatively good access to basic infrastructure such as roads and electricity supplies.45 45 CII/McKinsey (2007). 23
  35. 35. China and India: Opportunities and Challenges for UK Business Furthermore, as was discussed in Box 2.1, both the Chinese and Indian governments have recently placed increased emphasis on ensuring that the wealth from their economic growth is spread more widely. This is being driven by a range of policies such as; ●● The recent agricultural land reform in China to encourage more commercial farming and improve rural incomes. ●● China’s ‘Go West’ and ‘Revitalise North-Eastern China’ initiatives to encourage firms to relocate inland from the coastal regions. ●● India’s Bharat Nirman plan which injects billions of dollars of infrastructure investment into the rural economy. The effects of these changes are already apparent at the lower level of the income distribution, with the proportion of rural Indian households in the lowest income group falling by a third to 65% since 1985, while the number of rural Chinese households in extreme poverty has more than halved over a similar period. This trend is set to continue with lower middle class households becoming the largest rural income group.46 Pockets of more wealthy rural consumers are already present in certain regions, such as India’s more prosperous south-west, and will probably emerge as the early leaders in terms of rural consumer markets. These will tend to be clustered around China and India’s regional cities who are leading a ‘second wave’ of fast growing areas (See Box 2.6). The huge geographic dispersion of these regional cities, rural towns and villages poses a major obstacle to firms seeking to supply these markets. Establishing a regional presence supported by an effective distribution network is a real challenge. Often the only way to achieve this is through some form of partnership or joint venture with local businesses. In trying to reach these markets international companies also face stiff competition from domestic brands, many of whom have their foundations in strong regional operations. A case in point is Wahaha, China’s largest beverage producer. While Coca-Cola and Pepsi were building market share in China’s urban markets, through a combination of aggressive marketing and exploiting its large distribution network Wahaha has come to dominate the rural market. 46 McKinsey (2006, 2007). 24
  36. 36. BOx 2.6 ChINA ANd INdIA’S REgIONAl tOwNS ANd CItIES Although China and India have a number of ‘mega-cities’ such as Beijing, Shanghai, Delhi and Mumbai, the majority of their urban populations live in smaller urban areas. In China these tend to be regional cities with populations of 1m – 5m, whilst India has a large network of smaller cities and towns.47 A recent UKTI study examined the potential opportunities offered by a shortlist of 35 of the most promising Chinese regional cities; between them they accounted for 16% of China’s population and 36% of its GDP. Although average per capita incomes are still lower than in the major cities, they have been growing much more rapidly in regional cities, by an average of 15% a year or more.48 India has just over a third as many regional cities as China49, but while some multinationals already operate in these markets, most confine their activities to the major cities. One of the reasons for this is that unlike China, India’s regional cities taken together have not yet taken off as a consumer market, accounting for 23% of disposable income in 2004, compared to 39% for the eight major cities.50 Though major urban centres are expected to dominate spending, India’s smaller cities (those with a population between 0.5m – 1m) have almost as many rich and middle class households as the regional cities and in some cases have higher levels of disposable income. By 2025 around half of India’s middle class will live in these cities and smaller towns. 2.3 UK Export Performance to China and India “Don’t bargain for fish which are still in the water” Indian Proverb China and India’s rapid economic growth, rising urban incomes and increased openness are already driving dramatic increases in their imports of goods and services. As Figure 2.8 below illustrates, imports of goods to both countries have surged over the last five years, although India imports about a fifth as much as China.47484950 47 Estimates of the number of regional cities in China and India can vary significantly. For example the China Statistics Yearbook (2003) states that the country had 174 cities with a population over one million, while a recent UKTI study found 274 cities with a population in excess of 1m. Here we quote figures from UN (2007). 48 McKinsey (2006). 49 India has 37 cities with a population of 1 m – 5m, compared to 91 in China. 50 McKinsey (2007). 25
  37. 37. China and India: Opportunities and Challenges for UK Business Figure 2.8: Chinese and Indian Merchandise Imports China India Merchandise Imports ($bn) Merchandise Imports ($bn) 900,000 200,000 800,000 180,000 160,000 700,000 140,000 600,000 120,000 500,000 100,000 400,000 80,000 300,000 60,000 200,000 40,000 100,000 20,000 0 0 19 2 19 3 19 4 19 5 19 6 19 7 19 8 20 9 20 0 20 1 20 2 20 3 20 4 20 5 06 19 2 19 3 19 4 19 5 19 6 19 7 19 8 20 9 20 0 20 1 20 2 20 3 20 4 20 5 06 9 9 9 9 9 9 9 9 0 0 0 0 0 0 9 9 9 9 9 9 9 9 0 0 0 0 0 0 19 19 Other Machinery and Equipment Manufacturers Chemicals Fuels and Raw Materials Food and Animal Products Source: UN Comtrade Manufactures, specifically machinery, equipment and related parts now account for the bulk of Chinese merchandise imports (at around 45% of the total). Within this: ●● Imports of electronic goods and related parts expanded rapidly, from 10% of the total in 1992 to around 30% by 2006.51 ●● Of this roughly three quarters was in the form of components rather than finished products.52 51 China is now the second largest importer of ICT products in the world after the USA. UNCTAD (2008b). 52 This reflects the importance of the processing trade to China’s economy (the assembly of finished products from imported components for re-export). We return to this issue in more detail in Chapter 3. 26
  38. 38. As China has built up its own manufacturing capabilities it has become less reliant on imported heavy machinery, but increased its imports of more sophisticated equipment and raw materials. ●● The share of imports accounted for by heavy industrial machinery has halved since 1992, to 10%. ●● Imports of scientific equipment have grown by 44% a year since 2000, increasing their import share to around 6%.53 ●● Petroleum imports have grown by 26% a year since 1992, since 2000 imports of metals have grown by 28% a year. India’s merchandise imports are, if anything, even more dominated by raw materials and other primary commodities. ●● Petroleum and related products is the largest category with an import share of 30%. ●● Imports of metals are the second largest at around 9%. ●● India is a major market for jewels and precious metals (accounting for a fifth of world demand for gold).54 The trends in India’s imports of machinery and equipment reflect its less developed manufacturing base and the importance of ICT enabled services to the economy, for example; ●● Imports of heavy industrial machinery have been growing by 31% a year since 2000 (but are still below China’s in absolute terms). ●● Over the same period imports of telecommunications equipment have grown by 49% a year. Lack of data makes a similarly detailed breakdown of India and China’s service imports impossible; however top level data does allow us to observe a number of broad trends. From Figure 2.9 below we can see that China imports nearly twice as much in terms of services as India, although more recently the latter has been growing more rapidly. 53 China’s exports under this category have also increased, which is also indicative of processing trade. 54 Kannan (2008). 27
  39. 39. China and India: Opportunities and Challenges for UK Business Figure 2.9: Chinese and Indian Service Imports China India Service Imports ($bn) Service Imports ($bn) 120 60 100 50 80 40 60 30 40 20 20 10 0 0 19 2 19 3 19 4 19 5 19 6 19 7 19 8 20 9 20 0 20 1 20 2 20 3 20 4 20 5 06 19 2 19 3 19 4 19 5 19 6 19 7 19 8 20 9 20 0 20 1 20 2 20 3 20 4 05 9 9 9 9 9 9 9 9 0 0 0 0 0 0 9 9 9 9 9 9 9 9 0 0 0 0 0 19 19 Other Business Services Computer and Information Financial and Insurance Travel Transport Source: UNCTAD Both countries’ service imports are dominated by the transport, travel55 and other business services categories. But since 2000 it is imports of Computer & Information, and Financial services which have been growing the most quickly (by 45% and 37% a year respectively)56. Over the same period Indian imports of Communication and Construction services have surged (by 45% and 39% a year respectively). One interesting contrast between the two countries is in terms of their payments overseas relating to royalties and license fees. These account for less than 2% of India’s service imports, but over 6% of China’s (and have been rising much more rapidly in the latter). According to one academic we spoke with, as much as one third of some Chinese manufacturer’s costs consists of license fee payments overseas. thE uK’S ExPORtS tO ChINA ANd INdIA ARE dOMINAtEd By hIgh SKIll MANuFACtuRES ANd SERVICES UK exports to China and India have increased significantly over the last fifteen years. Since 1992 exports to China have grown by an average of 16% a year, while growth in exports to India has accelerated from an average of 10% a year 55 Travel primarily covers all purchases of goods and services of short run visitors (business and holidaymakers) to that country, it also includes travel for health or education related reasons. 56 Albeit from a very low base. 28
  40. 40. in the 1990s, to 14% a year since 2002. In common with many other developed countries, at present the UK trades substantially more with China than India. Figure 2.10: UK Merchandise Trade with China and India China – UK India – UK Merchandise Trade Merchandise Trade ($bn, 2005) ($bn, 2005) 30,000 6,000 25,000 5,000 20,000 4,000 15,000 3,000 10,000 2,000 5,000 1,000 0 0 Exports to UK Imports from UK Exports to UK Imports from UK Other Electronic Components Electronics High Skill Manufactures Medium Skill Manufactures Low Skill Manufactures Labour Intensive Manufactures Primary Commodities Source: UN COMTRADE Figure 2.10 provides a breakdown of the UK’s trade in goods with China and India using a product classification57 which distinguishes manufactured goods by skill intensity rather than by product. As one would expect the UK’s merchandise exports to these countries are dominated by higher skill manufactured products, while our imports are concentrated in labour intensive and low skilled manufactures. There are two obvious anomalies in this data which deserve comment. Firstly, the UK appears to export a large amount of labour intensive manufactures to India. This is caused by our exports of precious stones and metals, which is largely on a re-export basis and hence does not reflect domestic production. Secondly, the UK imports a large amount of electronic goods and components from China (see section 3.1). 57 UNCTAD (2007) Trade and Development Report p116 – This uses 3 digit SITC Rev 3 COMMTRADE data. 29
  41. 41. China and India: Opportunities and Challenges for UK Business Figure 2.11: UK Services Trade with China and India China – UK India – UK Services Trade Services Trade ($bn, 2006) ($bn, 2006) 1600 1600 1400 1400 1200 1200 1000 1000 800 800 600 600 400 400 200 200 0 0 Exports to UK Imports from UK Exports to UK Imports from UK Other Business Services Computers and Information Financial and Insurance Travel Transport Source: UNCTAD Figure 2.11 above provides a breakdown of the UK’s trade with China and India on the services side. India’s service imports from the UK reflect our world leading position in terms of finance and business related services; however these form a smaller proportion of our exports to China. 30
  42. 42. dESPItE thE StRONg gROwth IN gOOdS ExPORtS tO ChINA ANd INdIA thE uK hAS SEEN ItS ShARE OF thE tOtAl dEClINE. Figure 2.12: Shares of China and India’s Goods Imports China India Import Share Import Share 20% 10% 18% 9% 16% 8% 14% 7% 12% 6% 10% 5% 8% 4% 6% 3% 4% 2% 2% 1% 0% 0% UK USA Japan Germany France UK USA Japan Germany France 1992 2000 2006 Source: UN COMTRADE The UK has seen strong growth in its merchandise exports to China and India over the last two decades, even while its share of the total has declined. However, the rapid growth in trade with China and India means that the UK has also seen its share of their goods imports decline relative to that of our major competitors. Using detailed trade data it is possible to break down the changes in the UK’s share of Chinese and Indian goods imports into the contribution from two main components: ●● Changes in the product structure of Chinese and Indian import demand. ●● Changes in the sector share, that is, how much the UK sold within those product categories it exports to China and India. Thus for example if China’s import demand had shifted away from the types of products the UK exports we would expect to see this reflected in the contribution of the former, while a reduction in the UK’s share in particular sectors would be picked up by the latter. 31