What’s ahead for the Middle Class?

Stephen DeAngelis

March 13, 2009

American politicians continually claim they are watching out for the middle class. But few pundits can agree on what constitutes “the middle class.” A Wikipedia entry about the middle class recognizes the ambiguity that surrounds the term:

“The term ‘middle class’ has a long history and has had many, sometimes contradictory, meanings. It was once defined by exception as an intermediate social class between the nobility and the peasantry of Europe. While the nobility owned the countryside, and the peasantry worked the countryside, a new bourgeoisie (literally ‘town-dwellers’) arose around mercantile functions in the city. This had the result that the middle class were often the most wealthy stratum of society (whereas today many take the term to refer by definition to the only-moderately wealthy). … Within capitalism, middle class initially referred to the bourgeoisie and petit bourgeoisie. However, with the immiserisation and proletarianisation of much of the petit bourgeois world, and the growth of finance capitalism, middle class came to refer to the combination of labour aristocracy, professionals and white collar workers. The size of the middle class depends on how it is defined, whether by education, wealth, environment of upbringing, social network, manners or values, etc. These are all related, though far from deterministically dependent. … In the United States by the end of the twentieth century, more people identified themselves as middle class than as lower or ‘working’ class.”

Frankly, that sounds like something out of the Communist Manifesto. I suspect that most people who consider themselves middle class make enough money to obtain the necessities of life and have enough left over for some discretionary spending. Proponents of globalization have trumpeted the fact that two billion more people joined the middle class during the last wave of globalization (before the current recession began). The Economist published a special report on “the new middle class” and asks an important question in the introductory article to that report, “what if they sink back into poverty?” [“Two billion more bourgeois,” 14 February 2009 print edition]. The special report caught my attention because one of the goals of Enterra Solutions’ Development-in-a-Box™ offering is to help emerging market countries bolster their middle class. The article succinctly expresses why this is so important.

“During the past 15 years a new middle class has sprung up in emerging markets, producing a silent revolution in human affairs—a revolution of wealth-creation and new aspirations. The change has been silent because its beneficiaries have gone about transforming countries unobtrusively while enjoying the fruits of success. But that success has been a product of growth.”

As many economies begin to shrivel, The Economist wonders how those who have tasted success will respond when aspirations and reality clash. The article introduces the discussion by providing its own definition of the term “the new middle class.”

“The new middle consists of people with about a third of their income left for discretionary spending after providing basic food and shelter. They are neither rich, inheriting enough to escape the struggle for existence, nor poor, living from hand to mouth, or season to season. One of their most important characteristics is variety: middle-class people vary hugely by background, profession and income.”

The article notes that historically middle classes do not emerge gradually; rather, they blossom like a field of flowers after spring’s first rain. Economically speaking, this new middle class is important because its ranks are filled with new consumers. The Economist asserts, however, that it is more than consumerism that makes the new middle class important.

“As people emerge into the middle class, they do not merely create a new market. They think and behave differently. They are more open-minded, more concerned about their children’s future, more influenced by abstract values than traditional mores. … Ideologically they lean towards free markets and democracy, which tend to be better than other systems at balancing out varied and conflicting interests. … Such people are happier, more optimistic and more supportive of democracy than are the poor. These attitudes transform countries and economies. The middle class is more likely to invest in new products and new technologies than the rich, who tend to defend their existing assets. It is better able than the poor to leap barriers to entry into business and can therefore set up companies big enough to generate jobs. With its aspirations and capacity for delayed gratification, the middle class is more likely to invest in education and other sources of human capital, which are vital to prosperity. For years, policymakers have tied economic success to the rich (‘trickle-down economics’) and to the poor (‘inclusive growth’). But it is the middle class that is the real motor of economic growth.”

The article asserts that the future of the new middle class is now threatened. As “products” of globalization, many of the new middle class are connected to the export sector. As that sector shrinks, so do their prospects for a continued bright future. The magazine claims that the stakes could not be higher. Why? The Economist claims that for the first time in history more than half of the world’s population is middle class. Snatch hope from that many people and what their reaction will be is anyone’s guess. In the past, tyrants have exploited bad times to establish authoritarian regimes. We are already seeing signs emerge. Approval of the recent referendum in Venezuela that eliminates presidential term limits may be the first salvo in a war against democracy and free markets. Ensuring that the new middle class doesn’t lose hope is critical for the developed world as well as the developing world [“Burgeoning bourgeoisie,” The Economist, 14 February 2009 print edition].

“With the global economy facing the biggest slump since the 1930s, the World Bank says that ‘a new engine of private demand growth will be needed, and we see a likely candidate in the still largely untapped consumption potential of the rapidly expanding middle classes in the large emerging-market countries.'”

One interesting theory presented in the above article is that the middle class can be defined by the “one-third rule.”

“Diana Farrell, who is now a member of America’s National Economic Council but until recently worked for McKinsey, a consultancy that has spent a lot of time studying the middle classes, reckons they begin at roughly the point where people have a third of their income left for discretionary spending after providing for basic food and shelter. This allows them not just to buy things like fridges or cars but to improve their health care or plan for their children’s education.”

The article also asserts that the global middle class is bifurcated. Part of the middle class, the article argues, would be considered middle class by whatever standard one wants to use. The other, and more numerous, group is only middle class when its members are compared to other people living in the developing world. They call this group the “developing middle class.” This developing middle class appears quickly once a developing country hits what the article calls the “sweet spot” — “the moment when poor countries can get the maximum benefit from their cheap labour through international trade, before they price themselves out of world markets for cheap goods or are able to compete with rich countries in making high-value ones.” In our Development-in-a-Box™ discussions, we tell leaders of emerging market countries that achieving a minimum level of competency across a number of areas (such as, security, governance, rule of law, social well-being, and infrastructure) is necessary for them to reach this sweet spot. The Economist is optimistic that more and more developing countries are going to achieve their sweet spots.

“The surge across the poverty line is a period of accelerating growth both for the new middle class and for the country it inhabits. That should continue for a couple of decades. By most estimates, the global middle class will more than double in number between now and 2030. This will have profound social consequences, as happened in previous middle-class surges.”

Another interesting article in The Economist‘s special report explained “why the new middle classes are so good for their countries’ economies” [“Notions of shopkeepers“]. The article begins by noting that it’s a marketer’s dream to be able to sell something (anything from toothpaste to computers) to the teeming masses in China, India, and Brazil. Success and riches would be guaranteed. The problem, of course, is that those consumers are found in varied situations (from crowded cities to rural villages) and their needs and tastes are just as varied. Nevertheless, the article claims that “village shopkeepers and the yuppie shoppers are changing the economies of both their home countries and the globe.” It also puts forth a theory for why the middle class matters.

“Surjit Bhalla reckons that the larger a country’s middle class, the faster its economic growth: according to his calculations, a nation’s growth rate rises by half a point every time the size of the middle class increases by ten percentage points (so if a country’s middle class accounts for 50% of the population, it will, other things being equal, have a growth rate one percentage point higher than a country whose middle class makes up 30%).”

That’s a win-win situation. A win for those joining the middle class from the ranks of the impoverished and a win for the country as it generates more resources to build infrastructure and provide social services. The magazine then asserts that the single most important factor in developing a middle class and stimulating growth is the implementation of good economic policies.

“The middle class and growth go hand in hand because they are both results of something else: economic policies. In essence, the policies that made possible China’s vast increase in wealth over the past 30 years were determined by just one man: Deng Xiaoping. There was no frustrated incipient middle class urging change in 1978. It was a similar story in India in 1991: the middle class grew bigger thanks to the willingness of Manmohan Singh, then the finance minister, to tear up the ‘Licence Raj’. At first shrug, the expansion of the middle class seems to be a consequence of change elsewhere, not a cause of anything in its own right.”

I agree with the magazine’s assessment. That is why the first place I try and sell Development-in-a-Box™ is to the governments of developing countries. If you get the framework correct, you have a much better chance of building a sound economy and fostering a prosperous middle class. I have often asserted that economic reforms precede political reforms. Economic reform begins with changes in economic policies. The article goes on to note that it is the middle class that eventually insists on reforms and has the power to get them implemented.

“To grasp the true economic significance of the global middle class, says Daron Acemoglu of the Massachusetts Institute of Technology (MIT), you have to look at the second main reason why it contributes to growth. It is more committed than the elite to a mixed, competitive economy.”

Because members of the new middle class remember the conditions from which they arose, they insist on investments in human capital (i.e., in education and healthcare). These investments help secure a better future for the next generation as well as for the country. The article also claims that many members of the new middle class are natural entrepreneurs. As readers of this blog know, I believe that entrepreneurs are critical for helping economies grow.

 

Considering that The Economist‘s special report on the new middle class was published at a time when the bad news about the economy was sweeping across the globe like a flash flood in the Nevada desert, its upbeat message was both remarkable and surprising. Its conclusion was that “The recession may bring middle-class growth to a halt for a while—but not for long” [“Suspended animation“]. Since the magazine had already asserted that the new middle class is the global economy’s engine, its optimism is encouraging. If its predictions prove true, “over the next two or three decades, an expanding global middle class could boost economic growth and encourage democracy (or at least more liberal politics). It could also press for global public goods, such as tougher limits on greenhouse-gas emissions (middle-class people are more inclined than others to worry about the environment).” The question, of course, is whether The Economist‘s rosy predictions are likely to come true. It admits that “a reversal of middle-class fortunes could have serious effects” and that “the middle class faces problems across the board: jobs (its members are more likely than the poor to be employed by companies that depend on exports or outsourcing); assets (they have invested in property and shares but house prices and stockmarkets have crashed); and finance (they have put their money in banks or have borrowed from credit companies that are exposed to global markets).” So why the optimism?

“The middle class is different: meritocratic, thrifty, individualistic, committed to education. Some of these attributes and attitudes may be permanent, or at least only partially subject to the vagaries of the economic cycle. Admittedly there is little hard evidence from emerging markets to support or contradict this assertion. But the middle classes in America and Europe do not seem to have changed their outlook radically during slumps. … The spread of the internet and mobile phones may also have reinforced the middle class’s fear of being cut off from the technology and information on offer in the rest of the world. So if—perhaps a big if—the global recession lasts no more than a couple of years, it seems reasonable to expect the engine of middle-class formation to start humming again when growth picks up. There will be another portion of Maslow’s pyramid to climb, another political system to change, another step to take towards a global middle class. Until then, there will be a pause, but not an end, to what Marx called ‘the most revolutionary part’ the middle class has played in human affairs.”

I share in The Economist‘s optimism and continue to work with business and government leaders around the world to try and help find ways out of the current recession. Leaders with clear vision and courage continue to build the capacities that will help them now and establish a better foundation for growth in the future. For more on the global class, read Tom Barnett’s Weblog  for 13 March 2009.