Consumption and China’s Slowing Economy

Dalian large Shopping Mall 2005

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Now that MTD is a bit more “user friendly,” we’ve started to receive more comments from our readers. I’m delighted with this trend and encourage all of you to send along your thoughts on China and the articles that appear on the site. It lets me know what’s on your mind and enables me to be more responsive in what I write.

Our recent article on China’s tightening measures elicited several comments on the political and economic aspects of China’s actions

On politics, one reader wrote, “Unfortunately, much of China’s local government’s funds come directly from the sale of land. This makes any attempt to curb housing prices difficult.”

It is true that land sales are an important source of revenue for local governments in China. In fact, this point was emphasized by an official from a 1.5 million population county level city in Sichuan Province who we met this week. The major sources of revenues for this particular city, which has an annual GDP of approximately RMB 10 billion ($1.6 billion), are annual allocations from the provincial government, local taxes, borrowings and land sales.

However, land sales and the construction of more housing increases supply, which, on balance, tends to dampen prices. Strong demand is the driving force for increased prices, and the government is taking a number of steps to slow things down.

First of all, the tightening measures discussed in our article are making it very difficult for developers to obtain the financing needed to construct new buildings, thereby reducing supply. Secondly, the government now restricts purchases of apartments in many cities to residents of that city. In other words, if a person does not have a hukou,  or residence permit, in the cities that are controlled in this way, he or she is not allowed to purchase an apartment. This obviously impacts demand, particularly in popular cities like Beijing and Shanghai.

With respect to the economy, Tim D. wrote, “The dip in sales for machinery and autos raises another concern. Doesn’t this affect the problem with domestic consumption? From my understanding with the imbalance of trade, China should be looking to stimulate domestic consumption, or am I mistaken?”

Tim’s question, or a version of it, comes up frequently. For example, I received the following e-mail last week from an investment manager who has owned shares of China Yucahi (NYSE: CYD), China’s largest diesel engine company, for some time:

Good afternoon from the U.S. I just wanted to write and check in – as it has been quite some time since we have “spoken.” How are things over in China? I sold my entire position in China Yuchai……Are things over there really slowing as much as I think they are?

You may also notice that commentators on “Squawk Box” and other popular financial news shows often cite “China’s slowing economy” as cause for a market correction, a drop in commodity prices or some other event.

It is certainly true that China’s economy is slowing. However, it’s important to realize that it is slowing from double digit growth in past years, to growth of from 9.0 to 9.5 percent in 2011. By any measure, that is very fast growth for any economy and qualifies China as the fastest growing big economy in the world.

While sales of autos or construction machinery may be flat to declining this year, it’s also important to bear in mind that both sectors have had exceptionally strong growth in recent years. For example, sales of passenger cars increased by 33 percent, and sales of heavy duty trucks, the kind that use Yuchai engines, increased by 60 percent, in 2010. Both were at all time record levels last year. Despite the “breather” that these markets may be taking in 2011, China consumption makes the country the largest market in the world, by far, for each type of vehicle.

Meanwhile, the Chinese consumer is spending. From the long lines at the Apple store in Beijing, the crowded restaurants and the sales of fashion items, it’s hard to believe how much consumption is occurring in all parts of the country. A recent story in China Daily had this to say about the consumption of even the most expensive luxury goods in China today:

As if tuned to the tempo of the conductor’s baton, the orchestra of the world’s top fashion houses is playing a crescendo of price increases with surprising gusto.

The well-orchestrated move has shocked observers from New York to Shanghai, coming, as it does, at a time when demand for a pair of 3,600 yuan ($557) jeans from Prada SpA or a 9,600 yuan bag by Gucci SpA is widely expected to be doused by the unfolding debt crisis in Europe and the threat of a double-dip recession in the United States. As such, the orchestra should rather be playing diminuendo.

However, the Chinese audience is crying out for a march. While consumers in Japan, the United States and Europe are scrimping on luxury goods, the swelling ranks of big spenders in China are taking in whatever the “haute” houses in Paris or Milan can serve up. With demand underscored by an army of Chinese consumers, luxury brands feel no constraint in boosting their prices to cover rising costs and foreign exchange losses.

The price of an Amazona bag from the Madrid-based luxury clothing and accessories brand Loewe (a division of LVMH Group) soared to 22,000 yuan from 18,000 yuan in one week, a rise of more than 20 percent.

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One Response to “Consumption and China’s Slowing Economy”

  1. I was wondering if you have shared some of your thoughts about the typical Chinese management style. It is becoming more fashionable in Europe to be much more aware of management styles (Anglo-American versus Rhineland), but I noticed a growing number of managers tend to be interested in the Chinese management style. And with that I do not mean the examples of negotiation styles many management books are so keen to describe. But I mean the way a typical Chinese manager operates, makes decisions, steers, etcetera. I’m very curious for your thoughts about this.