BUENOS AIRES – Rising incomes across the developing world will bring some 400 million people into the middle class by 2020, up from 1.8 billion today. Their increasing spending power, especially on non-essential consumer goods and services, is being hailed as the great hope for the global economy. But closer examination of their economic circumstances suggests that these new consumers are neither as wealthy nor as secure as we may think.

The vast majority of the middle-class expansion is taking place in emerging Asia. But a similar socioeconomic shift in Latin America holds important lessons for rapidly growing markets everywhere. Latin Amercia’s middle class grew by around 50%, to 152 million, from 2003 to 2009, accounting for around 30% of the continent’s population – a proportion that undoubtedly has grown since.

This remarkable economic transformation has been presented as proof of successful pro-growth policies pursued in previous decades. Higher employment, rising wages, cash transfers to the poor, and state pensions have all helped to fuel progress. But, while policies that reduced the atrocious poverty and narrowed the yawning income inequality that persisted throughout the 1990’s must surely be applauded, the welfare gains associated with this performance may prove to be weaker than hoped.

An obvious problem lies in the fact that we measure the size of the middle class according to household-income data, but with little knowledge about these households’ patterns of saving. If today’s higher incomes are consumed and tomorrow’s incomes decline (which is likely if the economy slows), middle-class households with no savings buffer could easily slip back into poverty.

And, as a recent World Bank report (which I co-authored with Augusto de la Torre) pointed out, although data on household wealth are sparse, surveys suggest that low- and middle- income families, especially in Brazil and Argentina, tend to buy depreciating assets such as cars and televisions, rather than invest in houses. Such households are especially vulnerable if their purchases are financed by credit. With consumption rising faster than incomes, and with larger debts to finance, households may end up worse off – an irony often missed by those advocating wider access to banking services.

Nor do transfer payments or higher pensions provide much of a sustainable basis for spending. Almost every social-security system in the region is losing money. A declining proportion of paid benefits are covered by workers’ contributions, and few countries are saving enough to bridge the deficits. Eventually, the books must be balanced, and this will probably happen at the expense of future social spending.

Another, perhaps more important reason not to celebrate is that higher incomes do not necessarily translate into a better quality of life. A large part of household consumption includes public-sector goods and services. The same new middle-class worker who now enjoys a higher real income also endures a two-hour daily commute on packed and hazardous trains or buses, purchases private health insurance to escape the long lines in under-resourced hospitals, and pays for private education for their children to avoid decrepit school buildings operated by a strike-prone public-education system.

To some extent, poor public services can be seen as the flipside of the middle-class consumer boom in emerging economies. State subsidies and transfers have boosted private incomes, but often at the expense of investment in transport, security, and utilities.

In short, there is a difference between a society with a growing middle class and a middle-class society. Living standards in the latter are high (and more equal), owing primarily to the better public services that they provide.

This might seem an obvious shortcoming that governments would readily sort out. But there are political reasons why they do not. Voters tend to credit increases in minimum wages, pensions, and social transfers to the government that provides them. By contrast, the benefits of public investments are slower to be felt, and their beneficiaries are more diffuse. Politicians operating on short electoral cycles inevitably target public spending at potential supporters.

But, as societies become richer, the demands of the electorate become more nuanced. When disenchanted middle-class voters take to the streets, Latin America’s leaders will have to explain to them why better schools and trains tomorrow require saving more today.

 

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