Consumer Anxiety in China Set to Jolt Economy

Industrial production is slowing and jobs are shrinking in China.

H&M customers in Shanghai.

SHANGHAI — Falling exports, World Bank warnings and factory closures — China’s economy is being hit by the global economic downturn, and its consumers are feeling the pinch.

This story first appeared in the December 12, 2008 issue of WWD.  Subscribe Today.

Even as the Chinese government moves rapidly to stimulate the country’s economy and consumer spending via a $586 billion stimulus package, a consensus is growing: The nation won’t be able to escape the global recession unscathed, and a market once seen as a gold mine for fashion brands will wobble. The emergence of the new middle and upper classes in China distinguishes the current situation from the Asian financial crisis that brought the country’s first boom to an end in the late Nineties, as does China’s greater integration into and dependence upon world markets.

“I think there is going to be massive short-term hurt,” said Tom Doctoroff, greater China chief executive officer of the J. Walter Thompson advertising agency. “It is psychologically based: The middle class is newly minted, and this is China’s first time [dealing] with a slowdown and having a middle-class mind-set.”

As global demand for Chinese-made goods slackens because of the international economic crisis — with exports falling 2.2 percent last month, the largest drop in almost 10 years — China’s government said industrial production grew a lower-than-expected 8.2 percent in October, and consumer confidence in the third quarter dropped 0.3 points from the previous quarter. Reports on consumer confidence and spending were mixed for October, since sales invariably boom over the National Day holiday at the beginning of the month, then slump for the remainder.

About 10,000 textile and garment factories shut down in the first six months of the year and 20 million manufacturing jobs were eliminated, according to Chinese government figures. In addition, more expensive raw materials and higher labor costs have hurt the manufacturing sector.

“You’re going to see a massive stanch of capital that will impact a lot of small businesses,” Doctoroff said. “Then there’s the export problems, so export-driven provinces like Guangzhou and Fujian will see tens of thousands of businesses closing. That will bring a big crisis, although eventually their workers will be reabsorbed. [Government] investment will keep things growing. Social stability is necessary, but will take time. It will be bad, but not like the West.”

Access Asia research firm founder Paul French voiced a similar view. “People are starting to get very panicky. There is a feeling that they will hit a brick wall quickly and stop going out, shopping, eating out. Heads are down, people are riding it out. We’re seeing a slowdown on growth rates by a few percentages across the board,” he said.

That is one of the reasons the government unveiled a stimulus package last month. Earlier this week, at the conclusion of the three-day Central Economic Work Conference, Chinese officials again pledged to maintain “stable, healthy” growth in 2009.

Although Chinese consumer spending will slow its growth rate, a contraction seems unlikely, and increased consumer caution provides opportunities for midrange brands. “Domestic consumption won’t stop growing, but everything will go down a price level,” Doctoroff said. “Disposable income will be held on to or invested more cautiously. Even in the U.S., Wal-Mart is doing all right.”

Pierre Xiao Lu, author of “Elite China: Luxury Consumer Behavior in China” and an associate professor of marketing at Shanghai’s Fudan University, said “occasional buyers” will be the hardest-hit fashion consumers.

“Before, a lot had confidence and would save up a lot of money for that [Louis Vuitton] bag. But now they come back to their normal life and can’t afford that. The real buyers will maintain their lifestyles but change to more discreet styles, different from during boom times. For example, before people bought the logoed LV bag; now they will switch to something less obvious, less showy, with more internal quality.”

He doubted consumers would begin to trade down to domestic brands to save money, arguing the quality and status afforded by foreign brands is a difficult habit to shake. Rather, “midrange luxury will see strong growth, like Lacoste, Ralph Lauren, Tommy [Hilfiger] — accessible luxury,” he predicted. “Zara and H&M will continue their growth. Their products are very fashionable, their prices reasonable, they are international brands and their quality is good.”

“The real opportunity is for the midpriced apparel segment, like Levi’s,” Doctoroff said. “Status will never disappear, and the difference in quality is big enough….The smartest companies have the price tiers, plus accessories. Those with the portfolio to catch the downward slide are well positioned, but they are still expensive for China. They should make sure they position their brand as an investment in forward momentum, in the desire to move up the ladder. Be about public payoff, not internal indulgence. Be essential, not a luxury.”

China Market Research’s founder and director Shaun Rein concurred that midlevel retail brands like Giordano and Baleno stand to gain in the current climate, as do cheaper indulgences like fast food and domestic beer. “There is not the same fear here as in the U.S. Chinese are still shopping, but will move from what’s aspirational to what’s comfortable,” he said.

Despite the decline in consumer confidence, China Market Research Group’s recent survey of 150 young, middle-class workers in Shanghai and Beijing found that 70 percent are optimistic about the economy and will not change their consumer and lifestyle habits, while 80 percent had faith the Chinese government would make the right choices to keep the economy strong.

“The middle class, especially in lower- and middle-management levels, are the most optimistic,” Rein said. “Senior managers and those in manufacturing are less so. They are seeing everyday budgets cut, limitations on nonessential travel, limited hiring, so they are seeing the problems.”

Those under age 33 remain fairly shielded because they are not in the stock or property market and spend most or all of their salaries. Nonetheless, Rein said, “The linchpin will be whether they get big bonuses and salary increases of 15 percent at Chinese New Year.”

China’s white-collar workforce has become accustomed to annual salary increases of 10 to 15 percent, and many younger Chinese have no memory or life experience prior to China’s economic boom. It is this demographic that has driven consumer spending in China, and French predicted this consumer category is in for a rude awakening. He said a recent conversation with management at a Chinese lifestyle magazine illustrates the current mind-set.

“They told me that their ad sales guys came in wanting their annual 10 percent raise. They told them, ‘You’re joking.’ They’re selling less ads and have less pages to sell, and it’s not so easy to job hop anymore. The ad guys were stunned, they have no way of linking performance, pay and conditions,” French said.

Even in boom times, Chinese consumers are relatively conservative spenders and maintain a high savings rate, which has been a concern to the government as its stimulus package includes measures for rural consumers to buy products such as flat-screen TVs and washing machines. “In China, we have never seen a dramatic loosening of purse strings and decline in the savings rate,” Doctoroff said. “There are no spendthrifts in China, no matter how high up the ladder you go. Their attitude is that it’s all here today, gone tomorrow. Even China’s wealthy started out poor, there were no millionaires 10 years ago, there are no established wealthy here.”

Doctoroff added the slowdown will have its strongest impact on the middle class with newly acquired wealth. “This is their first extraneous macroeconomic shock, and they can’t control their money, so they will keep it safe. There’s no social security and no service economy, and disposable income is something they’re not used to having,” he said.

Observers stressed that younger, unmarried consumers are less exposed to a potential economic downturn. Most Chinese live with their parents before marrying, so they have few overhead expenses. Doctoroff said young, single consumers spend an average of 20 percent more than they earn. “So it seems that they are temporarily spendthrift, but in fact they are not: They see it as investing in their career and social standing,” he explained. “So, it is temporary.”

The young are even spending on credit, which generally is rare in China. “The Chinese are famous for their high savings rate,” Lu said. “They save their money for tomorrow, and do not spend it. However, for the 1980s-1990s generation, it is more acceptable to spend more money: They spend all of their salaries and get blamed by society for lacking the Chinese traditional way of living.”

In addition to cultural patterns, credit was rare because banks lacked the infrastructure and customers were high risk, but Rein said that is changing, with credit card use increasing at least 20 to 25 percent every year. There were 13 million credit cards in China in 2005, but by the end of 2007, there were 56 million, and up to 115 million by mid-2008, he said. However, those numbers remain small in China, where 1.1 billion debit cards are in use.

“People under 30 have a savings rate effectively of zero,” Rein said. “Young people are very optimistic, they have always had their salary going up. They want it now, instant gratification, not to save up and wait. They don’t have medical care and pensions to worry about. Of that 40 percent savings rate, it is 50 percent for people over 50.”