The rise of the Latin American middle class

21 Nov 2012 by Jim Fickett.

The World Bank defines the poor in Latin America as those earning less than 4 2005 US dollars per day, the vulnerable as those living on between $4 and $10; the middle class as those with income between $10 and $50, and the rest as rich. With these definitions the vulnerable and middle classes have grown considerably over the last 10 years, with the number of those in poverty falling. The World Bank projects that the middle class will continue to grow, but admits that there are risks.

A widely cited reason for investing in developing economies, and the global companies that sell to them, is that the global middle class has recently experienced considerable growth. When one tries to pin down this statement, however, and especially when one tries to understand whether this is a one-off phenomenon or a trend, it is not easy to find good data.

So it was with considerable pleasure that I found a recent World Bank report, dealing with the growth of the middle class in Latin America, which carefully defines not only the middle class, but three other classes, and gives solid data on longer-term trends. For the report, “Economic Mobility and the Rise of the Latin American Middle Class”, dated October 2012, there is both a short web-page overview and a 200-page PDF with all the details.

Since ClearOnMoney is more about facts and evidence than flashy headlines, let's start with the definitions (shocking, I know). The socioeconomic classes are defined in terms of income, and the unit for the income levels is 2005 US dollars:

PPP = purchasing power parity. Covered countries include Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, the Dominican Republic, El Salvador, Ecuador, Guatemala, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Uruguay, and República Bolivariana de Venezuela. Poverty lines and incomes are expressed in 2005 US$ PPP per day.

The most important definition, the lower income bound for the middle class, is defined in quite an interesting way, in terms of income security. You are middle class if you are well enough off that your chances of falling back into poverty are low.

Defining the middle class is not a trivial matter, and the choices depend on the perspective of the researcher. Sociologists and political scientists, for instance, usually define the middle class in terms of education (for example, above secondary), occupation (typically white collar), or asset ownership (including the ownership of basic consumer durables or a house). Economists, by contrast, tend to focus on income levels. This study adopts an economic perspective but, to arrive at a more robust—less arbitrary—definition, it anchors the income-based definition on the crucial notion of economic security (that is, a low probability of falling back into poverty). …

The concept of economic security is central to our approach because a defining feature of middle-class status is a certain degree of economic stability and resilience to shocks. We adopt a probability of falling into poverty over a five-year interval of 10 percent (approximately the average in countries such as Argentina, Colombia, and Costa Rica) as the maximum level of insecurity that may reasonably be borne by a household that is considered middle class. To map such a probability to a household income range, we ask— in those countries for which the right kinds of data are available—which income levels are typically associated with that level of insecurity. This exercise yields an income threshold of US$10 per day, at purchasing power parity (PPP) exchange rates, as our lower-bound per capita household income for the middle class. The upper income threshold for the middle class is set at US$50 per capita per day, based primarily on survey data considerations. According to these thresholds, a family of four would be considered middle class if its annual household income ranged between US$14,600 and US$73,000. …

Although US$10 per day (or US$3,650 per person per year) may not sound like a particularly demanding requirement for a family to be considered middle class, this income level corresponds to the 68th percentile of the Latin American income distribution in 2009. In other words, according to our definition, 68 percent of the region’s population—over two-thirds—lived below middle-class income standards in 2009. Not all of these people were poor, of course. If we use US$4 per day as a moderate poverty line for the region, as typically done by the World Bank, these 68.0 percent are split into 30.5 percent of the population living in poverty (US$0–US$4 per day) and 37.5 percent living between poverty and the middle class (US$4–US$10 per day). This second group is a segment of the population that is at risk of falling into poverty, with an estimated probability greater than 10 percent.

Above the vulnerable segment, about 30 percent of the Latin American population are in the middle class (US$10–US$50 per day) and some 2 percent are in the upper- income class (living on more than US$50 per day), to whom we will refer interchangeably as the rich or the elite.

Given those definitions, here are the core results of the study:

At least 40 percent of the region’s households are estimated to have moved upward in “socio-economic class” between 1995 and 2010. Most of the poor that moved up did not go directly to the middle class but rather joined a group sandwiched between the poor and the middle class, which the report calls the vulnerable class and is now the largest class in the region.

Still, the Latin American middle class did grow and very substantially: from 100 million people in 2000 to around 150 million by the end of the last decade. The emerging middle class differs, of course, from country to country, but there are a number of common threads. Middle class entrants are more educated than those they have left behind. They are also more likely to live in urban areas and to work in formal sector jobs. Middle class women are more likely to have fewer children and to participate in the labor force than women in the poor or vulnerable groups. …

After decades of stagnation, the size of the middle class in Latin America and the Caribbean recently expanded by 50 percent—from 103 million people in 2003 to 152 million (or 30 percent of the continent’s population) in 2009. Over the same period, as household incomes grew and inequality edged downward in most countries, the proportion of people in poverty fell markedly: from 44 percent to 30 percent. As a result, the middle class and the poor now account for roughly the same share of Latin America’s population. This is in stark contrast to the situation prevailing (for a long period) until about 10 years ago, when the share of the poor hovered around 2.5 times that of the middle class. This study investigates the nature, determinants, and possible consequences of this remarkable process of social transformation. …

popular images of the middle class—as being made up of either intrepid entrepreneurs (who start their own small businesses and pull themselves up the ladder by their own shoestrings) or lazy bureaucrats (comfortably relying on a government paycheck)—are inaccurate. Typically, the Latin American middle-class worker is a reasonably educated service worker, formally employed by a private enterprise in an urban area. …

Middle-class households typically have fewer children as well as women who join the labor force more frequently.

Here are the big trends:

It is quite interesting that most of the big change in class levels took place in just a few years – about 2003 to 2009 – and it looks as if change was leveling off in 2009, the latest data included in the report. The report projects that the middle class will continue to grow, and it is not unlikely that the leveling off in this graph is simply the result of the global recession. Still, there are serious risks to continued growth. One obvious one is that while the rise of the middle class was due in part to social mobility, it was also due in part to high rates of GDP growth in boom times, which may or may not continue. The report also makes a less obvious point that is negative for further progress, namely that those now in the middle class are often not very interested in engaging with, and improving, the society they live in. Rather, they are using their new-found status to wall themselves off and disengage:

the middle class (and the elite) participated disproportionately in the social security system (including old- age and disability pensions, unemployment protection, severance payments, and health insurance). But it tended to opt out of public education and health services, in particular. Instead, the upper and middle classes in Latin America often resorted to private alternatives to obtain these latter services. This tendency to opt out extended even to services where public provision should be the uncontested norm, such as electricity: in some Latin American countries, private ownership of electricity generators is still observed to rise with household income. The same applies for public security, with private security in closed condominiums not uncommon in a number of countries in the region. …

Latin America stands at a crossroads: will it break (further) with the fragmented social contract it inherited from its colonial past and continue to pursue greater parity of opportunities, or will it embrace even more forcefully a perverse model where the middle class opts out and fends for itself?

Clearly a rising middle class has been a very real trend, and those who have achieved better education and jobs are likely to fight hard to hold on to their gains. However I think the usual investor assumption that companies selling to the middle class have an assured long-term tailwind is too facile. Growth in the middle class was in part a boom-time phenomenon, and the trend definitely bears watching.