China exports Jul12.png2 great myths are helping to destroy company profits as we transition to the New Normal:

• In the West, it is that ‘recovery is just around the corner’
• In emerging economies, that everyone is now ‘middle class’

Sadly, this latter claim makes no sense at all.

The reason is that it is based on an income definition of $2 – $20/day, on a purchasing power parity basis; an annual income of just $730 – $7300.

This myth of a rising middle class unfortunately blinds many companies to the real opportunity. This is that countries like China have made great strides in moving people out of absolute poverty, defined as earning less than $1.25/day ($365 per year):

• 20 years ago, 41% of China’s population earned less than $1.25/day
• Today, only 1% are still living in absolute poverty

China’s own companies do not make this mistake. They know only Communist Party officials can afford luxury cars like the Audi A6L. It is the most popular luxury car, but still sold only 58k between January-May.

The real growth market is for people trading up from motor bikes. And China’s automakers are starting to flood the emerging economies with cheap and cheerful cars aimed at these buyers.

As the chart above shows from the New York Times, China’s vehicle exports are racing ahead. They were up 21% in January – May this year, and up 43% in May itself, as China’s new auto production comes online.

The reason is that they are very affordable:

• A Chery S21 costs just $5500 in Chile, for example
• A similarly featured Toyota costs $12000

Of course, today’s Chinese cars aren’t made to same quality as Western cars, nor to their safety standards. But by 2018, according to analysts JD Power, they will have caught up.

As we warn in chapter 6 of Boom, Gloom and the New Normal, it is wishful thinking to believe that demand from a new middle class in emerging economies will magically replace lost Western demand.

But companies who focus on affordability will do very well in the transition to the New Normal.