The Dawn of the Chinese Century

Turn off their electric alarm clock, brush their teeth, check the messages on their cell phone and drink a cup of coffee?

How ever many the answer is, the utility company, the makers of the PVC pipe under their bathroom sink, a memory chip manufacturer and Juan Valdez thanks each and every one of them for making another purchase. Chances are, if they were in this country at the time, your great-grandparents were woken by a rooster or the rising sun, had to bring in water from the pump before washing up in the morning, didn't yet have a phone in the house and considered coffee to be something of a luxury.

Call it the urbanization and suburbanization of America, perhaps the arrival of the American Century - how about the Birth of the Middle Class, or at least its rapid expansion from some people to most people. Post-World War II America has been a booming place.

But if you thought the explosion of the middle class in this country was something, cast your gaze on the Far East. In China, more than 70 percent of the country's 1.3 billion people are still living out in the rural hinterlands. And they all yearn to be part of that country's growing middle class.

What's that going to do to the price of coffee when a billion Chinese switch from drinking tea to yearning for a morning mug of coffee?

China's Academy of Social Sciences said in 2006 about 4 percent to 5 percent of the total population, rising to 12 percent to 15 percent of the population in big cities, was middle class, making somewhere between $18,000 and $36,000 a year in family income. Right now, $18,000 per year is more than 2.5 times the average annual pay in China, CASS said.

The International Herald Tribune reported in late December that the Chinese government wants to have at least have of that country's population be middle class by the year 2020 (a). At the current population totals, that means moving more than 500 million people from subsistence poverty levels to a middle class standard in just 12 years. By comparison, the combined populations of the United States, Canada, Mexico and the United Kingdom tallies about 503 million people. That's a healthy-sized middle class by any measure.

All of which is to say it sounds like a great time to be in the business of selling plumbing supplies in China. You can't truly be in the middle class without indoor plumbing, can you?

Of course, there's a lot more to China's moves than just new pressures in the cost of the resin to manufacture PVC pipe. The auto industry's international battle to be China's number one automaker is fairly well-documented. Starbuck's, McDonalds, Motorola - these companies and many more are all selling products in China and establishing market share there, or trying to.

While it is generally good for American stockholders to see American companies establish new markets and grow total sales volume, there are some challenges that come along with that.

Motorola and its competitors might be able to make more cell phones and sell them in China, but that may actually drive up the price on cell phones in the U.S. - as well as on scores of other electronics items.

The issue is raw materials. Take silver for example. If you want to produce electronic items with circuit boards in them, you generally need to make those items with silver. The same goes for circuit breakers, electric motor relays and scores of related uses. Fortunately, the use of silver in photography has dropped dramatically as digital images replace film, but industrial demand for silver is picking up that slack quickly, creating new upward demand for silver. And the price of silver has followed accordingly over the last couple of years.

Even in China, when McDonalds sells a hamburger, it comes served on a bun. You need wheat to make a bun. As the middle class in China grows, and McDonalds sells more hamburgers there, the competition for the wheat grown in Nebraska and elsewhere will grow. Any first year business student knows that demand drives up the price, perhaps one day causing enough price pressure that the Dollar Menu at McDonalds will one day be a thing of the past.

One wild card in the expansion of the Chinese middle class, as well as the middle class in other developing nations, is the technological advancements that will take place, even just between now and the year of China's 50 percent goal, 2020. It is hard to imagine the world today without cell phones, the internet, even cable television. One can only imagine what middle class-must haves are on the horizon over the next dozen years.

The United States remains the world's leader in total money spent on research and development projects according to the 2006 annual report from the Organization for Economic Cooperation and Development (OECD) (b), spending about $282 billion in 2001, the most recent year numbers were available for American, Japanese and Chinese R&D spending. But even there China is catching up. In 2001, Japan spent $104 billion on R&D and China moved that year to third place overall in total dollars spent to $60 billion US dollars. Chinese R&D spending that year accounted for 1.1 percent of its GDP, up from just 0.6 percent five years earlier. (According to the National Science Foundation, total U.S. R&D spending in 2004 had risen to $312.1 billion. More recent data for China was not available.)

About 40 percent of China's expenditure on research and development in 2001 was covered by the government and the rest 60 percent came from private enterprises. While U.S. spending on all R&D leads the nation in total dollars, the amount of dollars coming from government has fallen over the years, primarily due to a cutback in defense and space-related R&D about 10 years ago. The U.S. government funds about 30 percent of all R&D funding in this country, generally spending an amount equivalent to 2.5-2.7 percent of GDP on research. This level of GDP spending puts America about in the middle of the pack worldwide in terms of R&D spending as a ratio of GDP.

No one knows where the "next great idea" will come from or what it will be. But it is certain that the middle class will want it.

Suddenly, there's a whole lot more middle class to compete for the opportunity to purchase that great idea. By 2012, there will be even more people with disposable cash ready to buy.

Sounds like a great time to be selling PVC pipe in China.

Sources:

(a) "China Aims to Grow Its Middle Class" By Henry Sanderson, Associated Press, reported in International Herald Tribune, Dec. 26, 2007.

(b) "China rises to third in research, development spending" Xinhau News Agency, Nov. 11, 2003.

Additional Sources:

The World Fact Book, U.S. Central Intelligence Agency, www.cia.gov

InfoBrief, National Science Foundation, January 2007