It will happen around the world—but not here—as the middle class grows globally. Two big questions for investors trying to catch this trend: How big it will be, and how long it will last.
It’s big and it’s growing fast.
But that’s about all the experts agree on about the global middle class.
I don’t expect investors to achieve enlightenment where a generation of political and social scientists, development experts, investment strategists, and economists have tied themselves into statistical knots.
But because I think the growth of the global middle class will be the single most important investing trend for the next 20 years, I think investors ought to make a start at sorting through the myths.
I’d start by trying to distinguish myth from our imperfect grasp on reality in four areas.
Myth Vs. Reality No. 1: Middle Class at $2 a Day?
We don’t have a good head count on the rising global middle class.
The global middle class numbers 1.8 billon, or 28% of the world’s population, according to the Organisation for Economic Co-operation and Development.
According to The Economist magazine, however, in February 2009, more than half of the world’s population was already middle class. The World Bank projects that between 16% and 19% of the world’s population will be middle class by 2030.
When you’re talking about a world population of 7 billion, a difference of ten or 20 percentage points, or a decade or two, amounts to a lot of people.
The projections don’t necessarily get a whole lot closer when you go from a global perspective to an individual country.
The McKinsey Global Institute projects that India’s middle class of 50 million, less than 5% of the country’s population, will explode to 583 million by 2030. But economist Nancy Birdsall, the president of the Center for Global Development, calculates that India has no middle class at all.
McKinsey Global puts China’s middle class at 43% of its population today, on its way to 76% in 2025. Birdsall calculates that China’s middle class was just 3% of the population in 2005.
The extraordinary difference in these estimates comes from the difficulty in defining the middle class. By Birdsall’s definition, the middle class consists of people who earn more than $10 a day but who aren’t in the top 5% of the population by income. In 2005, India’s extremes of income inequality put just about everyone making more than $10 a day in the top 5% of the population.
The World Bank uses a range between the mean income levels in Brazil and Italy to define middle class. Other estimates say the middle class begins at either $2 a day (twice the World Bank’s $1-a-day definition of extreme poverty), or at $6 a day.
Myth Vs. Reality No. 2: No Single Middle Class
Forget about the search for a single definition of a global middle class. There isn’t one global middle class—there are at least two.
When I look at all these struggles to define “middle class,” the thing that jumps out is how much of the difficulty comes from trying to mash together the income levels of the existing middle class of the developed world with the income levels of the developing world.
If we take a behavioral approach to our definition of “middle class,” economists see middle-class activities such as discretionary buying for status or the use of credit to turn future wealth into current consumption emerging, to a degree, at income levels of $2 or $6 a day.
But while it may make an interesting intellectual challenge to try to somehow unify all these people at such disparate income levels under a single heading of middle class, from a business perspective—and thus an investing perspective—it makes no sense at all, and may in fact be dangerous to a company’s top line...and your portfolio.
This division into two—or more—middle classes shows up, for example, in the way Coca-Cola (KO) markets its products in China.
In urban areas, where incomes and aspirations are higher, Coke sells its products at prices that are just slightly lower than in Western markets. The relatively high price is part of a strategy to brand Coke as a product that consumers aspire to as incomes rise.
In rural areas, Coke sets its prices lower, sells in slightly smaller bottles, and requires customers to drink their Cokes on site and return the bottles to vendors. Coke is still an aspirational product for rural Chinese consumers with rising incomes, but the income bar is set lower.
Coke’s pricing strategy is being duplicated by other consumer companies, such as Procter & Gamble (PG), that sell their products in developing economies in smaller sizes and at lower prices, but the strategy suggests that there’s a sizable opening for companies to develop new products and create new brands that fit different price points for the developing-economy middle class.
If this massive developing-economy middle class doesn’t have the income of its developed-economy peers—at least not yet—it still has the aspirations to signal its new wealth and status.
Investors shouldn't assume that the fruits of the growth of the developing-economy middle class will automatically flow to developed-economy consumer companies. We’re seeing a process in the cellphone sector, for example, where Taiwan’s HTC and Korea’s Samsung have created brands that are displacing phones from Nokia (NOK) and successfully waging mind-share battles with Apple (AAPL).