A world changing consumer boom

The growth stories of China and India have always been different—China is well known for being the world's factory, while India's new wealth has been built on services. But the result is the same—a consumer boom that will reshape global markets. Over the next twenty years, 213 million Chinese households and 123 million Indian ones will begin to have discretionary income. That means 1.2 billion people hitting the world's consumer markets—a shopping spree of historic proportions.

If both countries continue on roughly their current growth paths, we will witness the creation of massive new consumer markets, as well as unprecedented reductions in poverty. The speed of the change will rival Japan's economic miracle of the 1950s to 1970s, as well as South Korea's more recent rise—but will be magnified over populations 10 and 30 times as large.

In China, rising incomes have the potential to lift over a hundred million people out of poverty. In 1985, 99 percent of the urban Chinese population lived in households earning less than $3 per person per day; by 2005, the number had dropped to 57 percent. We project that over the next 20 years, incomes will grow eight-fold, cutting China's poverty rate to just 16 percent. India's numbers are no less impressive. In 1985, 93 percent of the population lived on less than $1 per day; by 2005, it was 54 percent. The number is projected to decline to 22 percent by 2025. If current trends continue over the next two decades, India and China will have 1.8 billion fewer poor people than before economic reform. Both countries will also develop massive new middle classes, with China becoming the third largest consumer market in the world (behind Japan and the U.S.), and India taking fifth place.

International companies seeking to capitalize on this shift will face a number of challenges. Chief among them will be the fact that while 100,000 renminbi or 500,000 rupees buys a nice middle-class lifestyle in China or India (about $50,000 to $60,000 if adjusted for "purchasing-power parity" or "PPP"), when exchanged at actual exchange rates, the amounts look less attractive, around $11,000 to $12,000. As one executive put it, "You can't put PPP dollars in the bank, only real dollars." Multinationals thus face the dual challenge of adapting to local budgets as well as tastes. One example: Carrefour, the French retail giant, now has some of the highest-volume stores in China. Its trademark wide, brightly lit aisles display tanks of live eels, bullfrogs and turtles at prices that compete with China's "wet markets."

Further challenges include geography and distribution. In China, companies must choose which of its 177 cities with populations larger than one million to target. In India, there is no cold chain for food distribution, and a maze of internal tariffs and inspection points mean it can take days to ship short distances. Finally, foreign firms will face increasing pressure from local players.

Development of these markets is not a sure thing—keeping up past growth rates will require both countries to face up to common problems. First, despite rising wealth, public services remain weak. Households have high savings rates because they don't trust their governments to provide health care, education and pensions. Better government services would free up that savings for consumption, leading to more growth. Second, both financial systems are unmodernized and subject to significant political interference. The result is that capital is both mispriced and misallocated. Work by MGI shows that financial-system reform could add as much as 17 percent to Chinese GDP annually, and 7 percent to India's.

There are big unknowns. Will India's crumbling infrastructure put the brakes on growth? Will China's environmental issues slow its manufacturing juggernaut? Will the growing backlash against globalization and inequity harm both countries? But assuming they can rise to such challenges, increasing wealth and consumption are a matter of when rather than if. Part I of the China and India story, the rise of the worker, has already fundamentally changed the world order. Now part II, the rise of the consumer, is about to start. Is the world ready?

Farrell is director of the McKinsey Global Institute, McKinsey & Company's economic research arm, where Beinhocker is a senior fellow.

This article originally ran in Newsweek International.