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Avoiding pitfalls of the 'middle-income trap'
February 20, 2012, Monday
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THE Chinese economy stands at a pivotal point. China very swiftly grew from a lower middle-income country (per capita GDP of more than US$1,000) to an upper middle-income country (per capita GDP of more than US$4,000) between 2000 and 2010.
However, in order to make the transition to a high-income country (per capita GDP of more than US$12,500), the growth model has to change from one driven by fixed-asset investment to one driven equally by consumption, services and a higher level of technology. Barring that, China would risk falling into the middle-income trap where it can no longer compete with low-income countries on cost and cannot yet compete with advanced economies in terms of innovation and productivity.
The Chinese government is well aware of this issue. It has laid down measurements to avoid the middle-income trap, which include changes in economic structure. For the car market, that would mean a different distribution of industry segments in the transitional years.
In 2011, the three German brands BMW, Mercedes and Audi sold a total of 630,000 units in the US, while they sold about 720,000 units in China. China had a per capita GDP of about US$5,200 last year, while that of the US was about US$48,000. The premium market in China reached the same absolute level as in the US only because of a rather unequal income distribution, one of the warning signs of a country approaching the middle-income trap.
If China manages to change the economic structure to enable a transition to a high-income country, there would be a segment redistribution, with significantly fewer expensive cars sold that cost more than 300,000 yuan (US$47,600), which are more often than not imported cars.
There would also be somewhat fewer vehicles in the price segment between 200,000 yuan and 300,000 yuan, and more cars for first buyers on small budgets. The most important price segment would be about 150,000 yuan. We can assume that this transition in China might take about 25 to 30 years.
Over time, the distribution would approach that of developed countries, but the change has to start in the short term. If the share of the premium segment doesn't change over the next five years, we would take this as a strong indicator that China is, in fact, approaching the middle-income trap.
Market breakdown
In the high-income scenario, we assume that the car market in China would reach 250 cars per 1,000 people. That is significantly lower than in Western Europe, where the ratio is about 500 cars per 1,000 people. However, compared with Western Europe, China will be much more densely populated and the urbanization rate will be much higher.
In the middle-income trap scenario, we assume that the car density would only reach about 150 cars per 1,000 people, which is the rate of Brazil.
Under this model, car production in China would reach saturation in mid-2020s at 25 million cars a year and would stagnate thereafter. This means that in 10 years from now, the car market in China would be in the same situation as the US market in the 1990s, where intense competition led to irrational behavior, like excessive incentives, that eventually resulted in the near demise of General Motors, Ford and Chrysler.
Furthermore, we expect a very different distribution of the segments under the two scenarios.
In the high-income scenario, we expect a future distribution of segments similar to that of the US, with a significant portion of the market in the premium sector. In the middle income trap scenario, we expect a market like Brazil's, with most cars in the B- and low cost C-segment and an insignificant premium market.
In the high-income scenario, we would see a share of the premium market similar to that of the US. In that case, BMW, Mercedes and Audi would sell, on average, about 210,000 cars a year each in a market of about 12 million cars.
We should not be too happy about many expensive cars being sold in China in the next few years. That would only signify a significant breakdown of the car market is looming ahead.
However, in order to make the transition to a high-income country (per capita GDP of more than US$12,500), the growth model has to change from one driven by fixed-asset investment to one driven equally by consumption, services and a higher level of technology. Barring that, China would risk falling into the middle-income trap where it can no longer compete with low-income countries on cost and cannot yet compete with advanced economies in terms of innovation and productivity.
The Chinese government is well aware of this issue. It has laid down measurements to avoid the middle-income trap, which include changes in economic structure. For the car market, that would mean a different distribution of industry segments in the transitional years.
In 2011, the three German brands BMW, Mercedes and Audi sold a total of 630,000 units in the US, while they sold about 720,000 units in China. China had a per capita GDP of about US$5,200 last year, while that of the US was about US$48,000. The premium market in China reached the same absolute level as in the US only because of a rather unequal income distribution, one of the warning signs of a country approaching the middle-income trap.
If China manages to change the economic structure to enable a transition to a high-income country, there would be a segment redistribution, with significantly fewer expensive cars sold that cost more than 300,000 yuan (US$47,600), which are more often than not imported cars.
There would also be somewhat fewer vehicles in the price segment between 200,000 yuan and 300,000 yuan, and more cars for first buyers on small budgets. The most important price segment would be about 150,000 yuan. We can assume that this transition in China might take about 25 to 30 years.
Over time, the distribution would approach that of developed countries, but the change has to start in the short term. If the share of the premium segment doesn't change over the next five years, we would take this as a strong indicator that China is, in fact, approaching the middle-income trap.
Market breakdown
In the high-income scenario, we assume that the car market in China would reach 250 cars per 1,000 people. That is significantly lower than in Western Europe, where the ratio is about 500 cars per 1,000 people. However, compared with Western Europe, China will be much more densely populated and the urbanization rate will be much higher.
In the middle-income trap scenario, we assume that the car density would only reach about 150 cars per 1,000 people, which is the rate of Brazil.
Under this model, car production in China would reach saturation in mid-2020s at 25 million cars a year and would stagnate thereafter. This means that in 10 years from now, the car market in China would be in the same situation as the US market in the 1990s, where intense competition led to irrational behavior, like excessive incentives, that eventually resulted in the near demise of General Motors, Ford and Chrysler.
Furthermore, we expect a very different distribution of the segments under the two scenarios.
In the high-income scenario, we expect a future distribution of segments similar to that of the US, with a significant portion of the market in the premium sector. In the middle income trap scenario, we expect a market like Brazil's, with most cars in the B- and low cost C-segment and an insignificant premium market.
In the high-income scenario, we would see a share of the premium market similar to that of the US. In that case, BMW, Mercedes and Audi would sell, on average, about 210,000 cars a year each in a market of about 12 million cars.
We should not be too happy about many expensive cars being sold in China in the next few years. That would only signify a significant breakdown of the car market is looming ahead.
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