The rise of the global middle class--no trend is more important but let's separate myth from reality
10/18/2011 8:30 am EST
But that’s about all the experts do 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 since the growth of the global middle class will the single most important investing trend for the next twenty years, I think investors ought to make a start at sorting through the myths about the growth of the global middle class.
I’d start by trying to distinguish myth from our imperfect grasp on reality in four areas.
Myth versus Reality #1: We don’t really have a very good headcount on the rising global middle class.
The global middle class numbers 1.8 billon or 28% of the world’s population, according to the Organization for Economic Cooperation 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 10 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 look at an individual country. The McKinsey Global Institute projects that India’s small middle class of 50 million, less than 5% of the country’s population, will explode to 583 million by 2030. But economist Nancy Birdsall, 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 who is middle class. By Birdsall’s definition the middle class consists of people earning 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 level in Brazil and Italy to define middle class. Other estimates say the middle class begins at either $2 a day (which is just twice the World Bank’s $1 a day definition of extreme poverty) or at $6 a day.
Myth versus Reality #2: Forget about the search for a single definition of a global middle class. There really isn’t one global middle class—there are at least two. Looking at all these struggles to define “middle class,” the thing that jumps out at me 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 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 bottle sizes, 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 thinking about their being more than one middle class suggests that there’s a sizeable 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 just 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 cell phone sector, for example, where Taiwan’s HTC and Korea’s Samsung have created brands that in the developing economies are displacing phones from Nokia (NOK) and successfully waging mind-share battles with Apple (AAPL).
One of the reasons that companies such as Nestle (NSRGY) are investing so much money to set up research, development, and marketing centers in developing economies is a belief, well-founded I think, that the rise of a developing economy middle class requires more than simply transporting middle class products from the developed economies to the developing world with, perhaps, some tinkering at price points.
Following this perspective just a bit down the road raises the possibility that there are more than two middle classes—a developed and a developing economy model. There’s sufficient difference in income levels between the BRICS economies (Brazil, Russia, India, China, and South Africa) and the next wave of developing economies that look ready for global takeoff (countries such as Vietnam and Indonesia) to create openings for another group of companies catering to the aspirations and price points of these new middle class consumers.
Myth versus Reality #3: Yes, the story is the rise of the global middle class; it’s also about the relative decline of the developed world middle class. And how that will shift global middle class consumption and the global economy in general. Projections from the Organization for Economic Cooperation and Development (Yes, I know this data has its problems but we’ve got to work with what we’ve got.) show that the North American and European share of the global middle class in population will drop, respectively, to 10% from 18% and to 22% from 36% from by 2020 from 2009. Over the same period, the middle-class population of Asia Pacific will climb to 54% in 2020 from 28% in 2009.
But by spending instead of numbers the middle class consumers of the Asia Pacific region won’t reach a global majority position by 2020. Instead their share of global middle class spending will climb to just 42% by 2020 from 23% in 2009. Global consumer spending by the North American and European middle class will drop as a percentage of the global total to 46% in 2020 from 64% in 2009.
In other words, because numerically the biggest growth in the global middle class will take place in developing economies with relatively lower income levels, the global middle class will be increasingly dominated by consumers with lower incomes than those of middle class consumers in developed economies.
The world will have more middle class consumers but they will have relatively lower incomes than middle class consumers do today.
Some projections by Goldman Sachs capture this changing global economy. In 2007 the top seven countries in the world by the size of their economies were the United Stares, Japan, Germany, China, the United Kingdom, France, and Italy. All of these countries, except for China, ranked among the top 25 in the world by income as will. But while the United States ranked #9 on income and the United Kingdom #10, China ranked #56. The average income ranking for the seven largest economies by GDP was 21.
By 2030 only the United States, Japan, and Germany will remain in a top seven that will be headed by China, Goldman projects. And the average income ranking will have fallen to 37.
By 2050, according to Goldman, the income ranking for the top seven will have fallen further to 43 and from today’s developed world only the United States will still be among a top seven by GDP rank that will include China, India Brazil, Russia, Indonesia, and Mexico.
The global economy is going to be a lot more of a middle-income kind of place by 2030 and 2050 than it is now thanks to the a rise of the global middle class driven largely by the developing world.
Myth versus Reality #4: None of this may happen. What’s extraordinary about all studies of the rise of the global middle class that I read for this post is how little attention they pay to the readily apparent factors that might derail this trend. How about resource competition as this 1.8 billion strong middle class demands more houses, more cars, for oil, more gasoline. And what about the possible regional resource wars that will almost certainly result? What about scarcities of such basics as clean water or farmland that are already apparent in China and India? What about global climate change? Or the weak institutions of a country such as Russia?
If we’re going to project trends out to 2030 or 2050 don’t these need to get figured into the mix?
It’s not that there isn’t a vast literature on these problems—it’s just that the literature of the rise of the global middle class and the literature of Malthus, the literature that emphasizes the limits to growth, seem to talk past each other as if they lived in alternative universes.
Which does leave investors facing a huge challenge—not only do they have to prepare for the monumental changes to the global economy laid out by the rise of the global middle class experts but they have to constantly stay alert to the possibility that something in China or India or Brazil or Europe or the United States will derail this trend.
Yes, these are interesting times—when both good and bad times promise massive uncertainty.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Apple, Nestle, and Nokia as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/