The “rise of the middle class” has been a ubiquitous theme touted by emerging market (EM) investors for several years. In reality, upward social mobility and the emergence of a middle class in EM has been largely confined to China over the past decade. Given that China’s significance in the emerging world tends to obfuscate everything else when it comes to EM-related generalizations, it is not surprising that this misperception has taken root.
In this, the first in a two-part series on False Narratives in EM Equities, we demystify what the “rise of the middle class” truly means in an EM context. In part two, we delve into the controversial claim that emerging markets are the growth engine of the world.
“Companies, not countries,” we contend, is the narrative that should drive investment in emerging market equities. That said, neither narrative detracts from the fact that for long-term investors, we believe emerging markets provides a multitude of opportunities. As active, bottom-up investors, we focus on high-quality companies with sustainable advantages and options that are positioned to manifest over time. While these extraordinary companies are rare, they exist throughout the emerging markets. However, we believe that most investors’ adherence to false narratives clouds their ability to identify those unique opportunities, which creates an advantage for managers willing to take a more idiosyncratic approach over the long term.
What Constitutes the Middle Class?
Defining the term “middle class” is problematic, as there is no consensus. There is simply no authoritative way to develop consistent estimates across the heterogeneous landscape of EM economies as each has its own structural quirks in terms of income distribution and inequality. Countries like Qatar (which boasts the highest GDP per capita in the world) and the United Arab Emirates with small populations and lots of hydrocarbons distort the picture as they are very rich. East Asian countries with strong manufacturing bases and proximity to China are closer to developed nations in some respects. With a GDP per capita of approximately US$32,360 and US$24,400, respectively, South Korea and Taiwan have enjoyed such strong economic growth that they are as rich as developed markets like Italy and Spain.1 However, while there is little agreement on an approach to measuring the middle class in emerging markets, the trends evidenced by the data are strikingly similar.
For example, EM Advisors Group uses a threshold of $48,000 per household2 to determine the size of the middle class in EM. The World Data Lab’s Homi Kharas defines a four-person middle-class household as one that earns between $14,600 and $146,000 (in 2011 purchasing power parity terms). While these two organizations come to somewhat different conclusions about the ultimate size of the middle class, both show that there was modest growth in the 1990s followed by a huge acceleration from 2000-2010, before leveling off after 2010.