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Latin America’s Middle Class Potential

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Can Latin America's growing middle class deliver on its potential?

LBC SPECIAL
Knowledge@Wharton  

In most countries of the region, Latin America’s economic growth has been accompanied since 2000 by modern and innovative social policies that have contributed to significant reductions in inequality and widespread poverty. As a result, Latin America has a burgeoning middle class, whose progress in the coming years will determine the future of its nations, according to experts in various international organizations and educational institutions.

Indeed, an April report by the United Nations Economic Commission for Latin America and the Caribbean (ECLAC) titled, “Latin America’s Middle Class Is Changing and Growing,” emphasized that over the past 16 years, the aggregate number of middle class households in the 10 most populous countries in the region grew from 56 million to 128 million. Not surprisingly, the strong growth in the middle class has not been uniform. According to the “Latin American Economic Outlook 2011,” by the Organisation for Economic Cooperation and Development (OECD), the share of middle class people in the total population of various countries ranges from a comparatively high 56% in Uruguay to less than one-third in both Bolivia and Colombia. Somewhere in between those extremes, about 50% of the populations in Mexico and Chile belong to the middle class. 

The OECD report pointed to various factors in making these changes possible: “In brief, on a macro level, it’s worth emphasizing that the facilities for financing have improved, and there is strong demand for many of the products these countries export. Longer-term, the slow transformations involved in this process of development are also worth emphasizing, such as the decline in the family dependency ratio, and the rising rate at which women are incorporated into the labor market.”

All of this has created a middle class with its own unique characteristics, “which make it different from the stereotypical concept of the middle class that exists in most OECD countries,” Angel Gurria, secretary general of the OECD, said in his speech to the organization in Argentina. The buying power, educational level and job security of the Latin American middle class, Gurria noted, “are different from those of more advanced economies.”

Gurria added that the Latin American middle class includes a segment of the population that has overcome poverty, but which is still very vulnerable. “In most cases, these are people who do not have college degrees; who lack stable work, and are far from enjoying a fairly comfortable economic situation.” Latin America’s middle class, Gurria said, faces a real threat of downward social mobility.

What does the middle class contribute to the societies of Latin American countries? According to Carlos Malamud, professor of history at UNED, Spain’s national university of long-distance learning, and chief Latin American researcher at the Real Instituto Elcano, “The middle classes generate better expectations about the future and help to boost consumption in the country’s economy.” Second, he adds, economic growth in this part of the population “is accompanied by an improvement in education, which creates a higher level of trained workers, which leads to an increase in the competitiveness of the country.” Third, Malamud notes that these segments of the population “are often committed to conserving the political and social system,” so they also generate stability.

According to the OECD study, middle class homes have historically promoted economic development because they accumulate capital, as well as material goods, and typically enjoy education and good health. More recently, “The growing incomes of the middle strata in numerous developing economies have been viewed with enthusiasm because the growth of a stable middle class can act as a nationwide engine for consumption and demand." A strong middle class not only has a direct positive impact on economic development, experts say, but it can also have an indirect influence by supporting reasonable political programs and electoral platforms; more specifically, the sort of progressive educational, social and labor policies that promote inclusive growth.

But the real and tangible contributions of Latin America’s middle classes to society and the economy vary from one country to another. “There are some countries where [the middle class] has had a real impact on society, such as Brazil, which is experiencing a big boom in consumption," Malamud says. "But that is not happening everywhere. In Peru, for example, the middle class still does not believe in its position and its new status, so they are not becoming consumers.”

The ECLAC study includes data that demonstrates rising consumer spending in Latin American countries in recent years. The spread of consumer credit has provided greater access to durable goods and certain services. According to the Inter-American Development Bank and the World Bank, between 1990 and 2006 domestic credit grew from a total of 30% to 55% of the region’s aggregate gross domestic product (GDP). The greatest expansion took place in the Mercosur economic bloc, which comprises Argentina, Brazil, Paraguay and Uruguay.

Persistent Inequality

The rise of the middle class has had many positive implications for the region, but there is no guarantee that it will end one of the greatest problems of Latin American societies: social and economic inequality. “Normally, when the middle class grows, it leads to an increase in the incomes of the lowest strata [of society]," notes Arturo León, an economist and consultant at ECLAC. "This enables a portion of poor households to stop being poor, but that does not necessarily mean a reduction in the inequality of the distribution of income."

León argues that rising income levels can also benefit high-income families; perhaps even to a greater extent than they affect other classes -- and that can mean that inequality stays the same or even increases. “Actually, in the five countries [Argentina, Brazil, Chile, Mexico and Peru] that we examined in the study ... there were no significant changes in terms of inequality," León says. Along the same lines, Malamud suggests that a larger middle class and a reduction in inequality do not necessarily go hand in hand. “The reduction in inequality has not been produced in the same way as the reduction in poverty. Brazil is an example of a country in which this has occurred, but it is not something that has happened rapidly, but which has evolved slowly," Malamud notes. "Moreover, it depends on public policies [improving]; not on the individual condition of the people."

How the middle class in Latin America evolves in the future will depend on how its economies evolve, and on the social and fiscal policies that governments establish in order to strengthen this segment of the population.  “The growth that is anticipated for some countries in coming years will probably enable low-income homes to share in the characteristic consumption patterns and lifestyles of the middle class,” León says. “Nevertheless, sharp increases in the price of food, fuels and basic services [such as electricity, gas and water] could wind up putting an end to the trend toward improved real incomes; something that has been noticeable in many Latin American countries since the beginning of the 1990s." He notes that, because of a shortage of information, the ECLAC study does not cover the years prior to 2007, so there is no evidence about the impact of the global economic crisis of 2008-2009. "However, there is no doubt that the rapid expansion of the middle class that took place before 2008 must have been affected by the decline in the economic growth rate that resulted from the crisis."

According to the OECD report, if the middle class is to avoid falling back into the ranks of the disadvantaged, governments will have to take measures to strengthen it, and to promote rising social mobility. One of the best ways to do that is to improve education, León argues. “Among other possible measures, we should stress financing higher education through scholarships and loans, and establishing redistributive policies such as income supports,” the OECD report notes.

To carry out social policies of that sort, governments will need to deploy spending programs that are inevitably financed by tax revenues. At the same time, however, tax policies are being directly influenced by the development of the middle classes.

At the moment, Malamud says, “The middle classes are performing only a modest role in establishing the fiscal policies of the governments of the region, and these countries’ tax policies have yet to be fully developed. Fiscal pressures throughout the region are quite low because there is no overall vision that people must pay taxes. Any change in this situation will depend on how well politicians are able to get across the concept that [both] salaries and tax payments contribute to the economic and social improvement of the country.”

According to León, the expansion of the middle classes has a dual impact on public finances and fiscal policies. On the one hand, it leads to higher fiscal revenues, especially those that are derived from indirect taxes, due to the strong expansion of consumption that goes hand-in-hand with the swelling of the middle classes and the relatively high importance of such taxes in the tax burden of the countries of the region. On the other hand, “The new middle class puts growing pressure on public finances, which means higher government expenditures on services that demand more resources; for example, more spending on higher education, which, in turn, enables the middle class to strengthen its position in the social structure.”

The new members of the middle class also tend to push for more social protection.

“This trend is enhanced by the rapid incorporation of women into formal jobs, which is one of the factors that explains the growth in the income of homes that have joined the middle class in Latin America,” León says.

Republished with permission from http://www.knowledge.wharton.upenn.edu -- the online research and business analysis journal of the Wharton School of the University of Pennsylvania

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