Can the Asian middle class come of age?

Author: Homi Kharas, Brookings Institution

The Organization of Economic Cooperation and Development has just celebrated its 50th anniversary. Among the many achievements of this group of advanced economies is the unprecedented improvement in the material lives of millions of their citizens.

Between 1960 and 2010, the number of people who had middle class or better living standards in OECD member countries more than doubled from around 400 million to over 900 million. Poverty, by global standards, was essentially eradicated.

Asia today faces the same potential. Economies in south and east Asia have grown fast for two decades now, and in some Asian countries, growth has been sustained for much longer periods. Most south and east Asian economies have passed the World Bank’s threshold of a per capita GDP of $1000 to become classified as middle income countries. But that still does not mean that they have a large middle class, at least not by global standards. A global middle class is best defined by the spending of households, not the income available to the economy. When households can afford small luxury items, when they can purchase consumer durables like cell-phones, cars, motorcycles, refrigerators, maybe own their house, enjoy vacations and leisure and afford to educate their children and to provide them with good health care, then they can be classified as members of a global middle class. One rough definition of when this happens is when households spend at least $10/person/day in purchasing power parity terms. Of course, to be classified as middle class, one would also want to exclude the rich, or the group of households that does not worry about how much they spend, or the price of goods and services, but can afford whatever they choose. That group can be considered those who spend more than $100/person/day. It is using this definition that the extraordinary growth in the OECD middle class has been computed.

By the same definition, Asia today has a middle class of around 560 million people, of which 230 million are in the rich economies of Australia, Hong Kong, Japan, Korea, New Zealand, and Taiwan (China). The rest live in emerging economies. This latter group is growing very fast as these economies grow. In China, because of the low share of labour in GDP and very low rates of household expenditure, the middle class is small — perhaps only 12 percent of the population — compared to what one would expect from an economy at its level of development. India also has a small middle class by global standards, only about 5 percent of its population, because it is still a rather poor country. But the middle class in both China and India is growing at extraordinary rates. If China is successful in its policy ambition to foster wage growth at least as fast as GDP growth, and if it continues to grow at its potential, its middle class could swell to 50 percent of its population in just 12 years. India’s middle class could rise even more rapidly because Indian households benefit more from Indian growth than do Chinese households, given the prevailing distribution of income.

While the two Asian giants are obviously the most important drivers of the aggregate numbers of growth in the Asian middle class, the exciting possibility is that many large South and East Asian countries could enjoy the same kind of prosperity — Cambodia, Indonesia, Malaysia, Thailand and Vietnam are poised to become predominantly middle class countries within a decade to 15 years.

If changes like this occur, the face of Asia will change in every way. Asia is on a pace to add 2.5 billion people to the ranks of the world’s middle class in just 20 years, if it can sustain its growth. And that is now the ‘billions of people’ question facing Asian policymakers: can they find a growth model that permits them to grow fast even if there is slow growth in consumption in the advanced countries, heretofore the main source of demand for Asia’s exports? If they succeed, the next two decades will be a coming of age for Asian middle class households. If they fail, billions of Asian could fall back into poverty.

Asia should take heart from the experience of the advanced economies. After all, they grew fast by trading among themselves, allowing all countries to expand together on the back of productivity growth brought about by specialised production in a competitive environment. Asia too can re-orient its growth towards servicing its own domestic demands, because its middle class is already a $5 trillion market. That is easily large enough to for firms to achieve scale economies and productivity growth.

But Asia today faces challenges that the advanced countries did not face. It is experiencing growing levels of inequality and faces issues of social stability if it cannot find a more inclusive pattern of growth. It is susceptible to the effects of climate change, and must dramatically change its energy pattern away from fossil fuels. It faces strong competition for other natural resources, including food. It must generate savings to build its cities and other infrastructure at the same time as it encourages its households to spend — Europeans were already highly urbanised in 1960. It must deal with a world that seems to be facing ever more shocks. The advanced countries, by contrast, grew in an environment of unprecedented stability, anchored by the Bretton Woods system and later by effective cooperation among the G7 countries whenever global shocks had to be managed. And despite increased regional cooperation, Asia lacks an institutional framework to ensure that it can prevent crises in any single country from spreading to others in the region.

All this simply means that Asia is not pre-ordained to achieve rapid growth and a booming middle class simply because it has had economic success in the past. Like any mutual fund, past performance is no guarantee of future success. That maxim is especially true in middle income countries, and many once-strong growth performers have fallen into a trap of slow growth. But a confident Asia that looks to develop its own middle class, that makes smart choices about its cities, that educates its people, that opens up its services sectors, that starts to innovate and to tailor products to meet Asian consumer preferences will be an Asia that generates an enormous middle class. In less than 20 years, Asia’s middle class could come of age.

Homi Kharas is a senior fellow and deputy director for the Global Economy and Development program at The Brookings Institution.

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