Beware of the middle class

This article was an accompanying box for a recent Fund Strategy cover story I wrote on emerging markets.

The debate about the rising middle class in emerging economies often gives a misleading impression of the scale of prosperity that has been achieved.

It is true, and welcome, that people in the developing world have become much more affluent in recent decades. But the middle class is a long way from its western namesake. By some measures it is living at barely above subsistence levels rather than enjoying the living standards associated with the term “middle class” in the developed world.

Part of the problem is there no widely agreed measure of what constitutes the middle class. It is usually defined in relation to income but the threshold for entry to the middle class varies widely. This creates potential for confusion.

Perhaps the best place to start is the most inclusive definition of middle class. That is those who live above the $2-a-day poverty threshold. It is according to this definition that everyone who is not on the most meagre subsistence is counted as either middle class or wealthy.

It is important to recognise that this is not $2 in cash terms. Technically it is in 2005 international dollars at purchasing power parity. In practice this means the equivalent of what $2 what have bought in America in 2005.

This statistical procedure is used because the purchasing power of a dollar differs from country to country as prices vary. Therefore calculating a standard dollar means it is possible to make international comparisons. It also means that ‘$2 a day’ in these terms is probably significantly less when expressed in real money.

However, it has the advantage of making possible a meaningful comparison between income levels in America and in emerging economies. Martin Ravallion, a former research director at the World Bank, pointed out in a paper that the poverty line in America was defined as $13 a day in 2005 (The Developing World’s Bulging (but Vulnerable) ‘Middle Class’, World Bank Policy Research Working Paper 4816, January 2009). The level today is about $16.

In other words, many of those generally defined as well into the middle class in the emerging world – those with an income of $6,000 a year or more – would be considered below the poverty line in America. On the negative side, this means the emerging world is still a lot poorer than the ebullient discussion of a rising middle class often implies. On the other hand, it suggests there is still a lot of potential for catch-up growth.

Indeed, it is possible to work out roughly the difference between income levels in the advanced and emerging economies. The advanced economies account for about half of the world’s output and 18% of its population. Emerging economies account for the other half of the output but about 82% of the population. Therefore, on average, the advanced economies have an income per person of about 4.5 times that of the emerging world.

Finally, there are other ways of gauging entry into the middle class than an income threshold. According to one authoritative estimate there were about 160m cars in the G20 (largest) developing countries in 2010. Taking families into account, that would probably amount to a middle class of about 550m-660m people.

The gap between the living standards of the emerging middle class and even the average person in the West remains substantial.