Monday, November 23, 2009

Growing Domestic Consumption

Chinese economic development for the past two decades has depended on the rapid export growth of consumer goods to developed markets. The current and likely long term decline of export dependent growth has led the Chinese government to espouse and promote increasing domestic consumption in order to absorb manufacturing capacity and employment.

Three courses of fiscal policies have been taken: 1) employment and income support through infrastructure spending; 2) direct incentives to consumers and retailers, such as tax reductions, credits and subsidies; and 3) transfers payments to build a social safety net of healthcare, unemployment benefits and pension security are being put in place to stimulate consumption. But so far domestic consumption growth has been modest. It is assumed that these government policies will have growing force; but this may not be the case. Vast Infrastructure stimulus is time limited. Consumption subsidies in a savings culture reach a point of diminishing returns. A social safety only enhances the value of savings. Germany is a good case in point. It enacted Europe’s earliest safety net in the 19th century and retains to this day Europe’s highest savings rate.

Fiscal policies cannot alone overcome the historic habit of the Chinese people to save instead of spend. Cultural habits of saving that are rooted in a history of “tough times” can only be broken by the persuasive for of entrepreneurial marketing, in consort with pro-consumption fiscal policies. The willingness and ability of companies to invest in marketing to consumers is the horse that pulls the cart of government fiscal policy; not the other way around.

As an American marketer in China helping producers and retailers over the past ten years, I know the trepidation of Chinese shoppers to part with their cash; and what it takes to get them to do this. They will abide risks of spending for investment to grow their money, whether stocks, real estate or even gambling, but they hesitate to spend money on goods and services that perish with use.

It is natural for human beings to save so they do not have to depend on others to help them live decently when times get bad or when their earning power diminishes. Consumption, beyond necessities and immediate pleasures, is an artificial behavior. It only becomes “natural” once a new habit of consumerism takes its place..

Consumerism is not just buying more goods; it is a cultural disposition to spend money for new goods and services, beyond immediate need or pleasure. It is really spending for the joy and confidence of personal aspirations. The agent of this cultural change is the science and practice of marketing. Government must support it, but also constrain its inherent momentum through regulation to a point of sustainable balance between personal income and debt. The U.S. failed to regulate this measure. But China has the ideology and government means to control this.

The power of marketing to change habits rests upon a complex system of marketing management. This system encompasses sophisticated marketing research of personal and social consumer desires. It methodically segments consumer markets to find the small groups of specialized unmet desires. It makes tremendous investment in research, development, application and commercialization to launch goods and services to meet these desires. Statistical methods contrive to target the right consumer segments to a company’s product or service offering. Competition for target market share only sharpens the quality and features of offerings that make them even more desirable and expensive.

Enormous investment in branding imbed a high perceived value of these offerings into the consciousness of target consumers and make it easy for them to recognize and decide what they want to buy. Repetitive promotion whets the appetite by building consumer awareness, interest, and desire for these offerings. Distribution and retail (store and Internet) makes these offerings accessible to people for purchase. Pricing places an exchange value on these goods so that people feel they are getting fair or even more value than they are paying for. The sales process finalizes purchase transaction and completes the battle of marketing to overwhelm the natural resistance to save for future security against inevitable misfortunes. Companies spend billions of dollars to carry people through this process of spending down their savings and incurring debt to buy goods and services for their pleasure, career advancement, social status and power.

If the Chinese government wants to encourage domestic consumption, it has to support enterprise marketing in many ways. It has to gather household data from the official census and make it available to intermediaries to analyze, organize and sell its consumer relevance to enterprises. Government has to expand the distribution of credit cards and authorize banking and insurance mechanisms to process credit transactions and manage default risk. It has to support a security structure to authenticate purchases. It may, as in the U.S. during the 1960s and 70s, deduct consumer credit interest payments from personal income taxes. There is a vast inventory of Western government instruments that the Central government can draw upon to support enterprise marketing in China. One thing is clear, government fiscal policy alone cannot achieve the consumption growth it requires to offset export decline. It must support an enterprise marketing infrastructure.

I personally lived through the U.S. cultural change from saving to spending, and as a marketer contributed to it. Change began in the 1950s with the introduction of credit cards. In the mid 60s my brother Philip Kotler published his seminal 1st edition of Marketing Management. Philip turned marketing into a science and consumer companies followed his science with practice - building marketing organizations within the body of their companies and driving marketing campaigns that radiated through the media of the country. Universities business schools followed Philip’s direction and built an academic disciple to advance this science and practice. They turned out marketing managers for every consumer company. These managers and their cohort of advertising agencies, public relations, direct marketing companies and credit card issuers turned a savings culture into a spending culture. Multinational consumer companies spread this system to the four corners of the world.

Marketing produced a big change in U.S. personal savings. If 1975, well after the safety net was in place, savings were 17.6 percent of income. Marketing intensity brought this rate down to1.75% in 1985 and by 2005 down -.4%. By 2006 it fell to -1%. When we couple this with the fact that between 2000 and 2007 U.S. households nearly doubled their outstanding debt to $13.8 trillion—an unprecedented amount in both nominal terms and as a ratio of liabilities to disposable income (138 percent), you can appreciate the force of consumer marketing to change a culture. By 2006, consumption accounted for 70% of U.S. GDP.

If China wants to grow consumption for sustainable internal demand, it will have to cut its personal savings rate in half and turn trillions of Yuan into internal demand growth. It will have to invent its own approach to powerful marketing with enough regulatory control to prevent the evaporation of savings and the kind of debt explosion that precipitated the U.S. financial crash of 2007. China’s socialist economy, unlike the U.S. free market economy can accomplish this. The fact that a trend can become excessive if unchecked does not mean that its regulated moderation should be dismissed.

China’s path to marketing must be also be mindful that foreign companies in China know how to market and have the deep pockets to penetrate Chinese consumer demand. The marketing organizations of Chinese companies today cannot match this experience. If the China wants its own enterprises to profit from consumer growth if will have to encourage and support Chinese companies to build marketing organizations and branding, promotion and distribution capabilities. Chinese universities will have to take marketing seriously and steer good business minds to the marketing disciple, instead of the finance discipline towards which they now headed.

An effective policy of consumption that will befit Chinese enterprise requires a deep cultural shift in the thinking of Chinese leadership. This is new stage for China. Deng Xiaoping initiated an economic development policy based on export cost advantage. The export policy of the 1980s was a great leap for Chinese leadership from decades of internal planned economy. But it was still production focused and carried forward the industrialization mentality of the planned economy, except directed to external demand rather than internal development.

Consumption of a scale to absorb long terms export decline is “a horse of a different color.” It requires a cultural leap to focus production of what consumers want. There is no heritage of this in China’s modern history. It is a new stage of China’s socialist market economy based on the idea that people should enjoy life today, rather than fear the future. This view challenges the normal disposition of leaders to await global economic recovery for renewed export growth. This normal view is really a gamble that may not succeed.