Middle class in emerging economies

The Pew Research Center and The Economist conducted a joint survey (full report here) on middle class attitudes on 16 issues like environment, democracy, religion, values, life satisfaction etc in thirteen emerging economies. The Economist has an informative survey that draws in from the aforementioned study and other materials to paint a largely optimistic picture of the burgeoning middle class in emerging economies. A few observations from both studies

1. Assuming an average earning per day of $10-100, it has been estimated that the middle class’s share of the whole world’s population rose from one-third to 57%between 1990 and 2006.



As the graphic below on China indicates, as economic growth gathered pace in the emerging economies, the middle class category has surged. In China, the middle class share of the population surged from 15% in 1990 to 62% in 2005, and in India it is projected by the NCAER to grow from 5% in 2005 20% by 2015 and over 40% by 2025. The same is true of other emerging economies.



2. Middle class are far more likely to describe themselves as being satisfied than are poor ones, far more likely than the poor to expect a better life in future, and "when they make it into the middle class, people in emerging markets want the kind of governance associated with rich nations".



3. The new middle classes contribute a lot to a country’s growth, efficiency and equity—as consumers, as investors in "human capital" and because they engage in a wider range of economic activities than the rich and are more likely to create jobs than the poor. The demands of middle-class consumers in the developing world feed investment in new sorts of production, which raises income levels and changes the way business is conducted. They also tend to promote liberalisation and, indirectly, democracy by moving their countries away from the politics of patronage.

Surjit Bhalla reckons that the larger a country’s middle class, the faster its economic growth - a nation’s growth rate rises by half a point every time the size of the middle class increases by ten percentage points. William Easterly estimates that countries will large middle class have "higher levels of income and growth... more human capital and infrastructure accumulation... better economic policies, more democracy, less political instability, a more ‘modern’ sectoral structure and more urbanisation." On his measurement, an increase of one standard deviation in the middle class’s share of national income is associated with one extra percentage point of growth per person.

4. As Daron Acemoglu (and here) and others have suggested, the middle class is more committed than the elite to a mixed, competitive economy. Unlike the elites, the middle class does not have a political monopoly to defend, and its members are therefore more willing to invest in businesses and technologies that might offer competition to the elite; they are also more likely to be open to the outside world. So middle-class growth, trade openness and new businesses tend to go together.

5. Though the causatory links between middle class and democracy are mixed, it is undeniable that a thriving middle class would be a welcome force in the emergence and sustenance of democracy. Its crucial feature of heterogeneity and wide range of interest groups and occupations - software engineers, shopkeepers, teachers etc - means that its influence on the political system is multi-dimensional and inclusive. As Acemoglu says, a heterogeneous middle class makes the elites less fearful of democracy than it would otherwise be. Further, in many areas like opposition to punitive taxation, support for property rights and contract laws, and stability in economic policy making, the elites and middle class sail in the same boat.

6. The middle class is committed to education or "human capital accumulation" - more children at school and university, higher educational qualifications, more adult education and healthier lives - and health care. They also have a gift for entrepreneurship - create employment and productivity growth for the rest of society, since it is more likely to invest in new businesses and more willing to learn new ways of doing things.

7. More than both the rich and poor, the middle class are likely to be affected by the global economic slowdown as they face problems across the board - jobs (its members are more likely than the poor to be employed by companies that depend on exports or outsourcing); assets (they have invested in property and shares but house prices and stockmarkets have crashed); and finance (they have put their money in banks or have borrowed from credit companies that are exposed to global markets). Further, since a large proportion of the middle class are at the marging of the transition, they are especially vulnerable to any economic slowdown that would lead to reduction in incomes. Martin Ravallion of the World Bank (who describes middle class as those with incomes in the range of $2-13 a day), estimates that in 2005 one person in six in emerging markets was living on $2-3 a day, and that in the 1990-2005 period, more than ten times as many people joined the $2-9 tier than the $9-13 tier of middle class.

The survey therefore feels that the middle class are more likely to be victims of the down turn than be the people to pull the global economy out of recession, as hoped by the likes of World Bank.

8. In a middle class "Modern Society", people hope their children will do better than they have done themselves; which believes in merit, not privilege; competition, not inheritance; thrift, not conspicuous consumption; and which applauds personal effort rather than collective endeavour. It is a society summed up by the words of Margaret Thatcher, "We were taught to work jolly hard. We were taught self-reliance. We were taught to live within our income", and whose critical characteristic, according to Justin Yifu Lin, the World Bank’s chief economist, is "aspiration, and the means to pursue it".

It is a society that has moved beyond the lowest two of Maslow's needs hierarchy - physiological needs of food and shelter, sex and sleep, and the basic needs of safety and security - and embraced the higher needs - "belonging needs" (love, acceptance, affiliation), "esteem needs" (self-respect, social status, the approval of others) and finally "self-actualisation".

9. The survey distinguishes between the middle class created by the actions of the state, containing managers and white-collar employees of state-owned enterprises, accountants and civil servants, and teachers and doctors in the public education and health systems, and its equivalent created by its own efforts in the private sector, covering private entrepreneurs, their employees and archetypal small shopkeepers.

Citing the examples of the first category middle class of Russia and the Middle East, it feels that the public-sector sort may not have the same entrepreneurial drive, political impact or capacity to sustain high economic growth over time as the private sector ones.

Here is a survey of the different approaches to estimating the middle class.

Global financial landscape!

When will it end?

NYT reviews experts opinions on when the ongoing economic downturn will end.

1. With both the housing and the credit bubbles having burst, their stock portfolios down and their jobs threatened, consumers have been shocked into a new frugality. They are likely to be restrained for years to come... it looks to me as if this recession won’t end until late 2010 or early 2011.

Stephen Roach

2. If governments are quick and clear in their intentions and intervene in a coordinated way in both the real economy and the financial sector, we will probably have an unusually long and deep global recession through 2010. If they don’t, it is likely to be worse than that.

Micheal Spence

3. We are now in something more like a Great Recession... This is a crisis of excessive debt, the end of the Age of Leverage... At the moment, I find it quite easy to imagine two consecutive years of contraction. And I don’t rule out two more lean years after that.

Niall Ferguson

4. Nobody knows when this recession will end. Economic forecasting is a dark art, and predicting when recessions begin and end is its weakest link. That said, my best guess is that growth will return in the fourth quarter of this year.

Alan Blinder

5. Will last at least until the end of the year — 24 months, the longest since the Great Depression. Even if the gross domestic product grows in 2010, it is likely to be no higher than 1 percent. And at that rate, with the unemployment rate rising toward 10 percent, we will still be substantially in a recession... Even if appropriate aggressive policy actions were undertaken... the growth rate would not rise closer to 2 percent until 2011. So this recession may last 36 months.

We now face a 1 in 3 chance that, if appropriate policies are not put in place, this ugly U-shaped recession may turn into a more virulent L-shaped near-depression or stag-deflation (a deadly combination of economic stagnation and price deflation) like the one Japan experienced in the 1990s after its real estate and equity bubbles burst.

Nouriel Roubini

6. Counting the months of decline, however, is a narrow gauge of distress. A better metric is the length of time it takes the economy to recover to the level of per capita income at its prior peak... After the most severe banking crises around the world in the postwar period, the economy has taken an average of four years to return to its previous peak in personal income. After the Depression, it took the United States 10 years... the period during which the economy will remain below its earlier high-water mark will be protracted

Carmen Reinhart

7. If actions taken by the administration, the Congress and the Federal Reserve are successful in restoring some measure of financial stability — and only if that is the case, in my view — there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery.

Ben Bernanke

(HT: NYT)

Elections as stimulus - II

This blog has consistently argued that the coming general elections has the potential to provide one of the cheapest and most effective boost to the economy. In fact, the multiplier of such spending is likely to be the largest in view of the fact that most of the spending will be on goods and services which are produced and delivered by the local eocnomy itself.

The Businessline estimates the total spending would be in excess of Rs 15,000 Cr (this blog had estimated between Rs 15000-20000 Cr), mainly on aircraft, vehicles, fuel, posters, tents, audio equipment, food and paying the daily expenses for the core workers.



As good fortune would have it, many of the larger economies of the world are all set for elections in the next two years. Indonesia votes for COngressional and Presidential polls in mid-2009, and Brazil for Presidential polls in October 2010. Argentina, Chile, Colombia, Hungary, Poland, South Africa, and Ukraine too are set ot go to vote over the next two years. And as the graphic below suggests, the quantum of spending in elections, especially in India, Brazil, and South Africa is substantial enough to provide significant boost to the local economy. In other words, teh biggest contribution the politicians can make to these nations is by bringing forward their elections and then spending as much as they can afford in the ensuing elections!

Kyoto Protocol balance sheet

NYT has this excellent snapshot of how different countries have fared in achieving their targets on CO2 emissions (it had to be reduced to a percentage below the 1990 emissions by 2012) set by the Kyoto Protocol.



Given its stiff target, Germany has done remarkably well, a testament to the strong environment consciousness in German politics. Eastern Europe's performance, while exceptional, may have to be discounted for by some percentage, given the doubts about the quality of data supplied.

Ratings inflation and reforming the credit ratings market

Credit ratings market is ridden with conflicts of interest - the Credit ratings agencies (CRAs) conflict of understating credit risk to attract more business and the issuer conflict of purchasing only the most favorable ratings (issuer shopping). The other problems include - issuer payments influencing ratings, issuers shopping for ratings, CRA models varying in precision, barriers to entry creating market power for CRAs, and reputation considerations affectingt decision making. Two excellent NBER working papers examine the inherent dichotomies and incentive disotrtions in the present credit rating models and suggest alternatives.

Vasiliki Skreta and Laura Veldkamp write that an arrangement where security issuers can shop for ratings, solicit ratings from multiple agencies, and then select the best, distorts incentives for both the issuer and rating agencies. Increased competition, especially in the market for complex securities, will only exacerbate the distortions. They suggest two possible alternatives - investors initiated ratings and single rating agency.

Investor-initiated ratings suffer from information-market externalities - information leakage and market collapse due to demand complementarity. Since information requires a fixed cost to discover and is cheap to replicate, efficiency dictates that a discovered piece of information should be distributed to every asset investor so that all investors benefit from lower asset payoff risk. Yet, when investors have to pay for ratings themselves, either no investors or too few may
end up being informed. This problem can be overcome if the buyers of these assets are large investors (as is most likely the case for complex derivative products), who will find it valuable to purchase information.

The second possible solution would be to have one rating agency, a regulated monopoly, that rates every bond, thereby eliminating the possibility of ratings shopping. This does raise concerns about the qreliability of the informaiton provided, as incentives may not be aligned.

Patrick Bolton, Xavier Freixas, and Joel Shapiro find that CRAs are more prone to inflate ratings when there is a larger fraction of naive investors in the market who take ratings at face value or when the costs of their reputations taking a hit are lower. This makes ratings inflation distinct possibility during boom times when "the fraction of naive investors is higher" and "the reputation risk for CRAs of getting caught understating credit risk is lower".

They too find that due to issuer shopping, competition among CRAs in a duopoly is less efficient than having a monopoly CRA, in terms of both total ex-ante surplus and investor surplus. They propose three regulatory interventions, all of which suffer from some problems - the requirement of upfront payments to CRAs eliminates the conflicts of interest for CRAs but still permits shopping by issuers; the prohibition of shopping by enforcing disclosure of all ratings would benefit naive investors; an investors-pay solution may achieve an equivalent outcome but may be difficult to implement.

They finally argue that a "regulatory intervention requiring upfront payments for rating services (before CRAs propose a rating to the issuer) combined with mandatory disclosure of any rating produced by CRAs can substantially mitigate the conflicts of interest of both CRAs and issuers."

Update 1
Mark Thoma writes that "if the rating fees are sufficiently low, if the assets are sufficiently complex, and if the number of firms is sufficiently small - a case that may describe the recent market fairly well - a corner solution will emerge, i.e. it always pays - in expected terms - to collect all the ratings available and then make only the best rating public".

Update 2
James Surowiecki, in this post and this article, links to numerous articles about the problems inherent in rating agencies and proposals to reform them.

Globalization in retreat

Walden Bello calls it deglobalisation - the retreat of the process of global integration of goods, capital and jobs. The Economist draws attention to these - IMF predicts global growth of 0.5% in 2009, the worst in 60 years; world trade has plunged; foreign direct investment fell by 21% in 2008 to $1.4 trillion and will contract by another 12-15% in 2009; unemployment is expected to rise by 30m from 2007 levels by the end of the year. The graphic below caputures the mood nicely.