The Financial Express

Income inequality and the middle class

Income inequality and the middle class

The issue of rising income inequality has become the major global economic issue now, so much so that it has become a major political issue because there are growing evidences that middle-income earners are being hollowed out in developed economies. The picture is not much different in developing countries too.

In economic terms, income inequality is the large disparity in how income is distributed between individuals or groups or social classes within a country. Since the very beginning of the 1980s many economists in the US started to point out that income started to flow unequally to those at the top of the income spectrum.

The situation since then has not changed, the most affluent Americans were becoming richer much faster than Americans of modest means who were not gaining any increases in income. In the US, the share of country's income earned by middle income households has fallen by 21 per cent in the last three decades, while it increased by 75 per cent among top income earners.

This emerging trend in the early 1980s essentially reversed the trend that had emerged in the post WWII US where incomes of Americans of modest means grew appreciably faster than those of the most affluent Americans.

That was the beginning of emergence of the modern world's first mass middle class. Political leaders in the US had every reason to celebrate such a development and could claim that the country and the people were doing very well.  Aristotle, 2,400 years ago, in his book Politics argued that "a numerous middle class" is essential for a well-functioning democracy and a well administered state because they (the middle class) "obey the rule of reason". He, in fact, celebrated the middle class as modern-day politicians do.

In fact, middle income earners who are collectively identified as the middle class, have been an important target group in public policy debate in developed and emerging economies. However, it must be noted that different countries have different population groups in mind when they refer to the middle class. There is no commonly agreed or universally accepted definition of the middle-class, it is rather very fluid, even an uncertain term and at times politically charged.

Middle class is broadly a relative concept, indicating a stratum between at least two others. Middle-class people are not rich, but they are not poor either. In other words, it means not being poor, as defined by official national poverty lines makes one as belonging to the middle class. They have a reasonably comfortable and enjoyable life. They have some money to spend, it is purely based on consumption. Therefore, middle-class expansion has been used as an indicator of declining poverty.

On average, in OECD countries a middle-income household is defined as one which earns between 75 per cent and 200 per cent of the median national income. It is estimated that their share of total number of households declined from 64 per cent  in 1985 to 61 per cent in 20215. During this period in OECD countries, median income increased a third less than the average of the richest 10 per cent. At the same time the cost of essential consumption bundle of the middle-class lifestyle increased faster than inflation.

Overall, the middle class in OECD countries is facing a double squeeze, falling relative income and rising relative cost of living.  In fact, middle-income have barely grown, in both relative and absolute terms. So, there is a growing fear that the middle income earners are slowly but surely on the way to being hollowed out.

To further compound the problem one in six current middle-income jobs, face high risk of automation. There is now also a growing concern about middle class indebtedness which has been on the rise in these countries. More that 20 per cent of middle-income households spend more than they earn. Now over-indebtedness is higher for middle-income than for both low- and high-income households.

From the policy planner's perspective, a declining middle class poses a threat to both economic and political stability. The middle class plays an essential role in economic growth as well as in the social and political stability. This concern has led many to think about the causes contributing to this decline and what public policy responses should be there to address the issue.

This growing concern about a disappearing middle class is also found in Aristotle's Politics. He meticulously listed at least six arguments in support of the essentiality of a strong middle class for a well-functioning society.

Economists have observed that the slow but continuing squeezing out of the middle class in the developed world including the US has coincided with rising income inequality over the last 30 years  where income has flowed unequally to those at the very top of the income spectrum The average income of the richest 10 per cent of the population is about nine times that of the poorest 10 per cent across the OECD, up from seven times about 30 years ago.

The great post-war recovery flattened out in the early 1970s and since then the US has witnessed the end of the "American Dream" with ever increasing income inequality.

The Covid-19 pandemic is likely to add another dimension to middle class woes. The US economy has transited from manufacturing to information and finance with implications for employment impacting the middle class. The picture is not much different for other developed economies.

Three major explanations have been advanced for rising income inequality; first, technology and education argument or more precisely, changing skill requirements or skill mismatch impacting the labour market adjustments; second, trade and globalisation argument may sound bizarre to most economists but both Trump and now Biden administrations have embraced this argument for the economic woes of the US, and finally, the domestic government policies underpinned by neo-liberal doctrinaire view created an institutional framework that led to increasing income inequality.

All these have led to greatly diminished control over private interests where private profit motive now has extended to include education and health care and the delivery of many public services.

While the middle class is declining in developed economies, the gaining ground in emerging and developing economies is that these countries have seen a reduction in the number of people living under the poverty line. But this is largely an Asian phenomenon, basically it means China. That is also the view of Homi Kharas, an expert on the global middle class.

Kharas also in his recent study claimed that about 40 per cent of the world population are now considered as middle class and will continue to rise by 160 million a year. He further added that the overwhelming majority, some 88 per cent of this newly emerging middle would be in Asia.

The World Bank (WB) defines "middle class" as living on US$2-US$13 a day. The upper figure on the basis of the purchasing power parity (PPP) is roughly equivalent to the US poverty line as was in 2005, now it would be even below that. This puts the expanding middle class in Asia as equivalent to the American poor.

On the basis of the WB definition, it is estimated that in South Asia which includes Bangladesh has now a middle-class accounting for a little more than a quarter of the population. But this new middle class is mostly concentrated at just above US$2 a day.

However, the Asian Development Bank (ADB) defines "middle class" as earning US$2-US$20. According to a study conducted by McKinsey in 2007, middle class in India would rise to 583 million by 2025 from 50 million.  That puts almost 60 per cent of Indian population in the middle-class.

But the survey data indicate bulk of this Indian middle class is concentrated in the income bracket between US$2 and US$6 a day. It is interesting to note that pre-tax income growth as percentage of national income growth in India between 1980-2015 shows that the top 1 per cent grew by 401 per cent while the middle 40 per cent grew by 50 per cent. This possibly explains partly the reality facing the Indian middle class displaying a U-shaped curve of income inequality and its impact on the middle class.

In Bangladesh, US$2-US$4 a day adjusted by the PPP is generally considered as normal middle-class income. On that basis, 30 per cent of the population can be considered as belonging to middle class.  It is generally suggested that this middle class in Bangladesh - those on US$2-US$4 a day -- include street vendors, day laborers and also other contract-less and right-less workers. The scale of vulnerable employment in Bangladesh is huge.

The Bangladesh economic and social model is associated with substantial levels of social and economic exclusion, including high levels of income inequality. Such a system produces systemic inequities further aided by contemporary neo-liberal market economy.

According to the International Labour Organisation (ILO), in Bangladesh, 87 per cent of the labour force is employed in the informal economy. The same figure for India is estimated to be 81 per cent. With rising income inequality, using the international poverty lines, the middle class in South Asia will find that an overwhelming majority of them are vulnerable and at the risk of falling back into poverty.

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