scispace - formally typeset
Search or ask a question
Journal Article•DOI•

Reflections on the Macro Foundations of the Middle Class in the Developing World

Nancy Birdsall1•
Center for Global Development1
24 Oct 2007-Social Science Research Network-
TL;DR: In this paper, the authors define inclusive growth as growth conducive to increasing the size and economic command of the middle class, and present evidence of change in the size of the "middle class" for selected developing countries.
Abstract: In this working paper I define inclusive growth as growth conducive to increasing the size and economic command of the middle class. I suggest a definition of the middle class based on absolute and relative measures of country-based income distributions, and present evidence of change in the size of the "middle class" for selected developing countries. I then review how macroeconomic policies shape the environment and incentives for inclusive growth, focusing on three areas: fiscal discipline, the more rule-based the better; a fair tax and redistribution system; and a business friendly exchange rate.The adoption of macro policies that favor the middle class lays the foundation for more economically and politically sustainable development. While on the whole sound macro policy that is good for the middle class is also likely to be pro-poor, trade-offs may exist with respect to tax, expenditure and transfer programs and responses to economic shocks. Governments should consider the weighted welfare outcomes of alternative approaches to macro policy, rather than unweighted growth or overly weighted poverty outcomes.

Summary (1 min read)

Jump to: [Introduction] – [In the background: open economies and volatile global markets.] – [The tax side.] and [The expenditure side.]

Introduction

  • Growth that is shared, or so-called inclusive growth, is now widely embraced as the central economic goal for developing countries.
  • Inclusive growth includes but extends pro-poor growth, on the grounds that growth that is good for the large majority of people in developing countries is more likely to be economically and politically sustainable.
  • This definition implies some absolute and global threshold below which people are too poor to be middle class in any society, and some relative and local threshold above which people are at least in their own society “rich”.

In the background: open economies and volatile global markets.

  • I discuss macro policies below under the assumption that developing countries will continue the trend of the last two decades of maintaining or increasing their openness (including though with more caution with respect to capital) in an effort to fully exploit the potential benefits of integration into the global economy.
  • Countries where the middle class is large and growing are more likely to have the political support for adherence to such rules, in what could be a virtuous cycle of inclusive growth and good rule-based fiscal policy.
  • The resulting inflation hurt the poor, since the poor’s capacity to protect their earnings – through indexed savings for example – is limited.
  • Given high existing debt, Latin and other developing country governments determined to avoid new bouts of inflation have had to maintain tight fiscal policies in the last decade – in several cases including primary surpluses (i.e. fiscal surpluses net of interest payments) – as high as 4 and 5 percent of GDP (Table 4).
  • Latin America’s past patterns of stop-go spending (driven sometimes by periods of populist governments) have been a factor too, however, and have often been the cause of monetary policy that by accommodating fiscal indiscipline, further undermined investor confidence, raising interest rates and limiting job creation.

The tax side.

  • Inclusive growth requires not only keeping aggregate spending in line with aggregate revenues.
  • The experience in Latin America is discouraging.
  • 16 This section is based on Birdsall, de la Torre and Menezes (2007, forthcoming), Chapter 4, which includes citations to the relevant facts and analyses.
  • Martner and Aldunate (2006) estimate that indirect taxes accounted for about 56 percent of total tax revenues in Latin America and 31 percent of tax revenues in Europe in 2003-04.

The expenditure side.

  • Experience in Latin America also shows that the greatest hemorrhage in terms of inefficient, non-inclusive spending comes with poorly designed and politically driven pension programs.
  • In Inequality, Growth and Poverty in the Era of Liberalization and Globalization, eds. Giovanni Andrea Cornia.
  • Washington, D.C. Center for Global Development (http://www.cgdev.org/content/publications/detail/5853).

Did you find this useful? Give us your feedback

Figures (6)

Content maybe subject to copyright    Report

UC Santa Cruz
Mapping Global Inequalities
Title
Reflections on the Macro Foundations of the Middle Class in the Developing World
Permalink
https://escholarship.org/uc/item/4nt1n232
Author
Birdsall, Nancy
Publication Date
2007-11-28
eScholarship.org Powered by the California Digital Library
University of California
Working Paper Number 130
October 2007
Reflections on the Macro Foundations of the Middle Class in the
Developing World
By Nancy Birdsall
Abstract
In this working paper I define inclusive growth as growth conducive to increasing the size and
economic command of the middle class. I suggest a definition of the middle class based on absolute
and relative measures of country-based income distributions, and present evidence of change in the
size of the “middle class” for selected developing countries. I then review how macroeconomic
policies shape the environment and incentives for inclusive growth, focusing on three areas: fiscal
discipline, the more rule-based the better; a fair tax and redistribution system; and a business friendly
exchange rate.
The adoption of macro policies that favor the middle class lays the foundation for more economically
and politically sustainable development. While on the whole sound macro policy that is good for the
middle class is also likely to be pro-poor, tradeoffs may exist with respect to tax, expenditure and
transfer programs and responses to economic shocks. Governments should consider the weighted
welfare outcomes of alternative approaches to macro policy, rather than un-weighted growth or overly
weighted poverty outcomes.
The Center for Global Development is an independent think tank that works to reduce global poverty and
inequality through rigorous research and active engagement with the policy community. Use and
dissemination of this Working Paper is encouraged, however reproduced copies may not be used for
commercial purposes. Further usage is permitted under the terms of the Creative Commons License. The
views expressed in this paper are those of the author and should not be attributed to the directors or funders
of the Center for Global Development.
www.cgdev.org
Reflections on the Macro Foundations of the Middle Class in the
Developing World
Nancy Birdsall*
*President, Center for Global Development, Washington D.C. (www.cgdev.org). I am grateful to Nora
Lustig, John Williamson, Arvind Subramanian, and two anonymous referees for their comments on an
initial draft, and to Kevin Ummel for his help with data and to Karelle Samuda and Christine Park for their
research support.
1
Introduction
Growth that is shared, or so-called inclusive growth, is now widely embraced as the central
economic goal for developing countries. But definitions and empirical characterizations of
inclusive growth vary widely. In this brief I define and characterize empirically inclusive
growth as that growth that builds a middle class. I then review how macroeconomic
policies shape the environment and incentives for inclusive growth, focusing on three
areas: fiscal discipline, the more rule-based the better; a “fair” fisc with respect to revenues
and expenditures; and a business-friendly exchange rate. These are policies conducive to
growth; I do not mean to imply that they are underlying causes of growth. I rely heavily on
experience (mostly unhappy) of the mostly middle-income countries in Latin America. I
also refer briefly to the implications of the discussion for heavily aid-dependent low-
income countries, most of which are in sub-Saharan Africa.
From pro-poor growth to inclusive “middle class” growth
In the last several decades, pro-poor growth emerged as a gentle counterpoint to a singular
concern with growth alone (measured in terms of increases in per capita income), while
implicitly recognizing that growth, if not always sufficient for poverty reduction, is almost
certainly necessary.
1
Inclusive growth includes but extends pro-poor growth, on the
grounds that growth that is good for the large majority of people in developing countries is
more likely to be economically and politically sustainable. Growth that is sustained over
many decades matters because many low and middle-income countries that have had long
growth episodes – of eight to ten years – have subsequently suffered prolonged growth
collapses while still well short of the average per capita income levels which make possible
real gains in human development and general well-being.
2
For macro policies is there a meaningful distinction between those conducive to pro-poor
vs. inclusive growth? Sound fiscal and monetary policies that are pro-poor are also likely
to be good for the middle class on the whole. But tradeoffs may exist with respect to
specific tax, expenditure and transfer policies; and in the case of macroeconomic shocks,
middle class households, to the extent their members are small business owners or semi-
skilled workers in industry or services, may face greater relative losses of permanent
income than poor subsistence farmers.
In the end, the possible tensions or tradeoffs between strictly pro-poor and more inclusive
“middle-class” growth policies cannot be generalized. They must be assessed policy by
policy in each country, and are likely to change over time as circumstances change. One
message of this note is that policymakers in developing countries (and their international
supporters and advisers) should more systematically consider weighted welfare outcomes
when selecting and fine-tuning macro policies, rather than unweighted growth outcomes or
1
Kraay (2006).
2
Birdsall (2007) summarizes the evidence of this for Africa, based on Hausmann, Pritchett & Rodrik (2004)
which summarizes the evidence that many countries that have had long growth episodes subsequently have
growth collapses.
2
overly weighted poverty outcomes. A second is that where there are no tradeoffs, all the
better. The medium-term benefits of good macro policy for building a middle class argue
all the more for what are sometimes painful macro decisions in the short run.
Defining the middle class.
Inclusive growth implies an increase in the proportion of people in the middle class
(implying some exit of people out of poverty), and the proportion of total income they
command, implying gains in the middle at the “expense” either of the initially poor or the
initially rich.
3
I define the “middle class” to include people at or above the equivalent of
$10 day in 2005, and at or below the 90
th
percentile of the income distribution in their own
country
4
. This definition implies some absolute and global threshold below which people
are too poor to be middle class in any society, and some relative and local threshold above
which people are at least in their own society “rich”.
The absolute minimum can be thought of as a minimum income for a person or household
to have the economic security associated with middle class status in an integrated global
economy. The relative maximum, which obviously varies across countries, can be thought
of as excluding that portion of the population within a country whose income is most likely
to be from inherited wealth, or based on prior or current economic rents associated with
monopoly or other privileges, and thus less associated with productive and primarily labor
activity than for the non-rich. I set the threshold at the 90
th
decile of income because across
almost all developing countries for which we have information on income distributions,
Table 1 shows that the ratio of income of the 10
th
to the 9
th
decile ranges from two to more
than four and is far greater than the ratio of income of the 9
th
to the 8
th
decile. (For OECD
countries the 10/9 ratio also exceeds the 9/8 ratio but is always below two.)
Defined in this manner, an increase in the size and economic power of the middle class is
likely to signal that the underlying growth is based on wealth creation and productivity
gains in private activities and is thus self-sustaining and transformative (politically as well
as economically, as the more powerful middle demands government policies conducive to
wealth creation), as opposed to being driven largely by exploitation of natural resources, by
remittances, or by infusions of external aid.
Figure 1 (see Appendix table for more detail) shows the economic command of the middle
class so defined for selected countries, and the change in that indicator between 1990 and
2004. (There is no obvious association between the change in the size of the middle class
and change in the Gini over that period. For China middle class growth is associated with a
rising Gini while for India and Brazil it is associated with a declining Gini. The same is
true for other measures of inequality (not shown).
3
These implications depend in part on the relative gains or declines in income and share of the initially rich;
the statements assume that the rich are not losing in absolute terms.
4
For other recent definitions, see World Bank, 2007; Birdsall, Graham and Pettinato, 2000; and Bhalla,
forthcoming. Defining the top 10 percent of people in every country as “rich” implies that of the
approximate 30 million people in the U.S with 2004 monthly income at or above $6,059 are “rich”, while the
approximate 264 million in China with 2004 monthly income of just $406.70 are rich.
3
Citations
More filters
Journal Article•DOI•
The National Bureau of Economic Research

[...]

Geoffrey H. Moore
01 Jun 1950-The American Statistician
TL;DR: The National Bureau of Economic Research (NBRE) as mentioned in this paper is a private non-profit corporation, formed to conduct or assist in the making of exact and impartial investigations in the field of economic, social and industrial science, and to this end to cooperate with governments, universities, learned societies, and individuals.
Abstract: What manner of organization is the National Bureau of Economic Research? How does it select research topics? Who does the work and what kind of tasks do they perform? Where do the funds come from? How does the National Bureau safeguard the scientific quality of its findings? How are the results disseminated? Visitors to the National Bureau often ask these and similar questions; perhaps the answers will be of interest to readers of the American Statistician. The National Bureau of Economic Research is a private non-profit corporation, formed, according to its charter, "to conduct, or assist in the making of exact and impartial investigations in the field of economic, social and industrial science, and to this end to cooperate with governments, universities, learned societies, and individuals." Hence it is not a government agency, nor an adjunct of a university, nor does it sell research services. The revenue from the only products it does sell, publications, barely covers the printing costs. Its funds are contributed by philanthropic foundations, by trade and professional organizations, by business concerns, trade unions, and individuals. Contributions are usually on a yearly basis, but some grants cover several years. Some of the funds are earmarked for specific studies; the balance goes to support a general program of research. The National Bureau is governed by a Board of Directors numbering about thirty, selected to represent various institutions and diverse points of view on economic problems. Over the years since the Bureau was founded in 1920 this body of men has made a significant contribution to the development of scientific inquiry in economics, both within the National Bureau and outside. Such outstanding economists as Wesley C. Mitchell, George E. Roberts, Allyn A. Young, Edwin F. Gay, Thomas S. Adams, and John R. Commons have been among its members. At the present time professors from a dozen universities are on the Board. Also, Directors from each of the following organizations are elected: American Statistical Association, American Economic Association, American Farm Economic Association, Economic History Association, American Institute of Accountants, American Management Association, Congress of Industrial Organizations, and American Federation of Labor. Finally, there is a group of Directors at Large, men from varied walks of life with an abiding interest in economic research. The Board serves an important function not only in shaping the broad lines of the research program but also in safeguarding the quality of the results. Matters of policy requiring prompt action are handled by an Executive Committee of eleven, elected by the Board from its membership. Arthur F. Burns, the Director of Research, is the member of the Committee who is directly responsible for the research program. The members of the research staff, numbering about twenty-five, direct the individual studies, and are aided in their work by upwards of forty-five research assistants. A staff of typists, bookkeepers, mimeograph operators, etc., brings the total payroll of the National Bureau to roughly a hundred persons. William J. Carson, the Executive Director, handles the Bureau's finances, accounts, and other administrative matters. Not all the employees of the National Bureau work at the main office at 1819 Broadway, New York City. DuLr Financial Research Program is housed at "Hillside," an estate about 10 miles north of Manhattan overlooking the HuLdson River. Other National BureauL investigators are to be fotund at various universities throughout the United States, since cooperative arrangements are maintained with a number of universities that permit their facultv members to engage in National Butreau studies. Government agencies, too, cooperate in similar ways. Such cooperative relationships are a vital feature of our work, and we try to foster them in many ways. The growing acceptance on the part of universities of the view that research is part of the job of a faculty member has helped to make these efforts productive. For example, for a number of years we have appointed promising young men or women holding university positions as Research Associates for one year. The objective is to enable scholars to pursue their research interests in fields in which the National Bureau also has an interest. Since 1930 twenty-six Research Associates, coming from eighteen American colleges or universities and two foreign universities, have been appointed under the plan. The work of several committees is another example of cooperation for the purpose of advancing research. Two committees, one on financial and the other on fiscal research, help to guide our studies in these areas. They are composed of experts from universities, government agencies, and private business. In 1935 the Universities-National Bureau Committee was established for the express purpose of promoting contact

548 citations

Journal Article•DOI•
The Rise of a Middle Class in East and Southern Africa: Implications for Food System Transformation

[...]

David L. Tschirley1, Thomas Reardon1, Michael Dolislager1, Jason Snyder1•
Michigan State University1
01 Jan 2014-Journal of International Development
TL;DR: In this article, the authors show that 55% of the region's middle class is located in rural areas, while the import share of food expenditure does not rise with income in urban areas.
Abstract: We show five points regarding the middle class in developing East and Southern Africa: (1) 55 per cent of the region's middle class—37 per cent of the ‘non-vulnerable’ middle class—is rural; (2) 61–83 per cent of the middle class's food is purchased; (3) processed food occupies 70–80 per cent of the class's food expenditure, with similar shares in urban and rural areas; (4) perishable products account for 44–55 per cent of the class's expenditure. Policy attention to processing and to food products ‘beyond-grains’ thus needs to be ‘mainstreamed’; and (5) the import share of food expenditure does not rise with income in urban areas. © 2015 The Authors. Journal of International Development published by John Wiley & Sons, Ltd.

238 citations

Journal Article•DOI•
Do No Harm: Aid, Weak Institutions, and the Missing Middle in Africa

[...]

Nancy Birdsall1•
Center for Global Development1
01 Mar 2007-Social Science Research Network
TL;DR: The implicit assumption of the donor community is that Africa is trapped by its poverty, and that aid is necessary if it is to escape as discussed by the authors, and this assumption is reinforced by the small share of income of its independent middle strata.
Abstract: The implicit assumption of the donor community is that Africa is trapped by its poverty, and that aid is necessary if it is to escape This article suggests an alternative view: that Africa is caught in an institutional trap, signalled and reinforced by the small share of income of its independent middle strata Theory and historical experience elsewhere suggest that a robust middle-income group contributes critically to the creation and sustenance of healthy institutions, particularly of the state The article argues that if external aid is to be helpful for institution-building in Africa's weak and fragile states, donors need to emphasise not providing more aid but minimising the risks more aid poses for this group

113 citations

Cites background from "Reflections on the Macro Foundation..."

  • ...Birdsall (2007) defines a set of countries vulnerable to the negative effect of inequality on growth because their inequality is very high (at or above a Gini coefficient of .45) and their per capita income is below $5,000 (2005 US$)....

    [...]

Monograph•DOI•
Less Pretension, More Ambition : Development Policy in Times of Globalization

[...]

Peter van Lieshout, Robert Went, Monique Kremer
01 Jan 2010
TL;DR: Ontwikkelingshulp heeft onder de Nederlandse bevolking nog altijd een groot draagvlak, zo blijkt uit opinieonderzoek as discussed by the authors.
Abstract: Ontwikkelingshulp heeft onder de Nederlandse bevolking nog altijd een groot draagvlak, zo blijkt uit opinieonderzoek. Maar de twijfels nemen toe. Ook in de media worden steeds meer vraagtekens geplaatst bij de effecten van hulp. Met name de situatie in Afrika stelt velen teleur. Waarom geven we eigenlijk ontwikkelingshulp, en helpt die hulp? Wat weten we over ontwikkelingstrajecten van landen en over de mogelijkheid daar van buiten aan bij te dragen? Hoe relevant is hulp nog voor ontwikkelingslanden nu andere financiele stromen zoals remittances en buitenlandse investeringen (FDI) door globalisering zijn toegenomen? En heeft beleid gericht op thema's als klimaat, migratie, financiele stabiliteit, kennis, handel en veiligheid niet meer invloed op de ontwikkelingskansen van arme landen? Deze en andere vragen komen aan bod in dit rapport van de Wetenschappelijke Raad voor het Regeringsbeleid. Op basis van bijna vijfhonderd gesprekken in het veld en een uitgebreide bestudering van de literatuur formuleert de WRR aanbevelingen voor forse wijzigingen in de organisatie van ontwikkelinghulp, en voor gestructureerde aandacht voor terreinen die ontwikkelingsrelevant zijn en voor mondiale publieke goederen.

79 citations

Journal Article•DOI•
Middle Class Size in the Past, Present, and Future: A Description of Trends in Asia

[...]

Natalie Chun1•
Asian Development Bank1
01 Sep 2010-Social Science Research Network
TL;DR: In this paper, the authors describe the size of the middle class in developing Asia across countries and over time, based on an absolute measure of the Middle Class of $2-$20 (2005 purchasing power parity United States dollars).
Abstract: This paper describes the size of the middle class in developing Asia across countries and over time. Based on an absolute measure of the middle class of $2-$20 (2005 purchasing power parity United States dollars), it finds that between 1990 and 2008, the size of the middle class in developing Asia has grown dramatically in percentage share, absolute size, and purchasing power. However, there are large variations in the size and growth of the middle class across countries, with the primary growth of the middle class largely driven by the People’s Republic of China (PRC). Considerably smaller growth has occurred in many countries including Nepal and Sri Lanka. Still, a large portion of the middle class residing in the $2-$4 range are extremely vulnerable, and many of the poor in Asia remain in the PRC and India. This suggests that it may be good for policymakers to not only focus on countries that have lagged behind in terms of growth of the middle class, but that it should also concern itself with focusing on countries where there is still considerable room to build, and bolster the absolute size of the middle class in Asia.

62 citations

Additional excerpts

  • ...Birdsall (2007) uses a $10 (2005 PPP $) per person per day line to identify the middle class and simply requires that they make less than 90% of the income distribution in a given country, thus creating a middle class definition that is absolute at the bottom end and relative at the upper end of…...

    [...]

References
More filters
Journal Article•DOI•
Inequality and Growth in a Panel of Countries

[...]

Robert J. Barro1•
Harvard University1
01 Mar 2000-Journal of Economic Growth
TL;DR: In this paper, a broad panel of countries showed little overall relation between income inequality and rates of growth and investment, while the Kuznets curve is a clear empirical regularity, but it does not explain the bulk of variations in inequality across countries or over time.
Abstract: Evidence from a broad panel of countries shows little overall relation between income inequality and rates of growth and investment. For growth, higher inequality tends to retard growth in poor countries and encourage growth in richer places. The Kuznets curve—whereby inequality first increases and later decreases during the process of economic development—emerges as a clear empirical regularity. However, this relation does not explain the bulk of variations in inequality across countries or over time.

2,672 citations

Posted Content•
Fiscal Policy and Economic Growth: An Empirical Investigation

[...]

William Easterly1, Sergio Rebelo2•
New York University1, Northwestern University2
01 Oct 1993-Social Science Research Network
TL;DR: In this paper, the empirical regularities relating fiscal policy variables, the level of development and the rate of growth are described, and they employ historical data, recent cross-section data, and newly constructed public investment series.
Abstract: This paper describes the empirical regularities relating fiscal policy variables, the level of development and the rate of growth. We employ historical data, recent cross-section data, and newly constructed public investment series. Our main findings are: (i) there is a strong association between the development level and the fiscal structure: poor countries rely heavily on international trade taxes, while income taxes are only important in developed economies; (ii) fiscal policy is influenced by the scale of the economy, measured by its population; (iii) investment in transport and communication is consistently correlated with growth while the effects of taxation are difficult to isolate empirically.

1,863 citations

Journal Article•DOI•
Growth Accelerations

[...]

Ricardo Hausmann1, Lant Pritchett2, Dani Rodrik1•
Harvard University1, World Bank2
01 Dec 2005

975 citations

Economic commission for latin america and the caribbean - eclac

[...]

Gordon Brackstone
01 Jan 2003
TL;DR: The economic crisis in Latin America and the Caribbean reached dramatic proportions in 1988, and per capita output fell for the first time since the recession of 1981-1983, so that it amounted to barely the equivalent of that obtained back In 1978; inflation more than doubled, averaging an unprecedented 470%, and real wages and salaries decreased in most countries.
Abstract: In 1988 the economic crisis in Latin America and the Caribbean reached dramatic proportions. Per capita output fell for the first time since the recession of 1981-1983, so that it amounted to barely the equivalent of that obtained back In 1978; inflation more than doubled, averaging an unprecedented 470%, and real wages and salaries decreased in most countries (see table 1 and figure 1). This deterioration In economic conditions occurred despite lhe relative easing of external restrictions. Thus, most countries of the region, have distanced themselves ever mora from the alusiva goal of resuming a stable and sustained economic growth such as to enablethem to address the massive and serious social problems built up since the onset ol the crisis.

779 citations

Book•
Worlds Apart: Measuring International and Global Inequality

[...]

Branko Milanovic
29 May 2005
TL;DR: Milanovic et al. as discussed by the authors analyzed income distribution worldwide using household survey data from more than 100 countries and showed that inequality is shaped by complex forces often working in different directions.
Abstract: We are used to thinking about inequality within countries--about rich Americans versus poor Americans, for instance. But what about inequality between all citizens of the world? Worlds Apart addresses just how to measure global inequality among individuals, and shows that inequality is shaped by complex forces often working in different directions. Branko Milanovic, a top World Bank economist, analyzes income distribution worldwide using, for the first time, household survey data from more than 100 countries. He evenhandedly explains the main approaches to the problem, offers a more accurate way of measuring inequality among individuals, and discusses the relevant policies of first-world countries and nongovernmental organizations. Inequality has increased between nations over the last half century (richer countries have generally grown faster than poorer countries). And yet the two most populous nations, China and India, have also grown fast. But over the past two decades inequality within countries has increased. As complex as reconciling these three data trends may be, it is clear: the inequality between the world's individuals is staggering. At the turn of the twenty-first century, the richest 5 percent of people receive one-third of total global income, as much as the poorest 80 percent. While a few poor countries are catching up with the rich world, the differences between the richest and poorest individuals around the globe are huge and likely growing.

747 citations

Related Papers (5)
What is middle class about the middle classes around the world

[...]

01 Jan 2008-Journal of Economic Perspectives
Abhijit Banerjee, Esther Duflo
the middle class consensus and economic development

[...]

30 Nov 1999-Journal of Economic Growth
William Easterly
The developing world's bulging (but vulnerable) "middle class"

[...]

01 Jan 2009-World Development
Martin Ravallion
The Emerging Middle Class in Developing Countries

[...]

26 Jan 2010-Research Papers in Economics
Homi Kharas
Chapter 35 Economic policy formation: Theory and implementation (applied econometrics in the public sector)

[...]

01 Jan 1986-Handbook of Econometrics
Lawrence R. Klein
Frequently Asked Questions (18)
Q1. What contributions have the authors mentioned in the paper "Reflections on the macro foundations of the middle class in the developing world" ?

In this working paper I define inclusive growth as growth conducive to increasing the size and economic command of the middle class. Use and dissemination of this Working Paper is encouraged, however reproduced copies may not be used for commercial purposes. The views expressed in this paper are those of the author and should not be attributed to the directors or funders of the Center for Global Development. I suggest a definition of the middle class based on absolute and relative measures of country-based income distributions, and present evidence of change in the size of the “ middle class ” for selected developing countries. Further usage is permitted under the terms of the Creative Commons License. 

It is, for example, the secure middle class in mature market economies that is most likely to support policies that favor openness, maintain price stability and help ensure a competitive exchange rate. 

In China the rising Gini appears to reflect the Kuznetzian story of initial increases because people are moving from low-productivity sectors (e.g. subsistence agriculture) to higher productivity (e.g. urban manufacturing) activities. 

But because more open economies are more vulnerable to global financial and other shocks, and because the integration process produces losers (at least in the short run) as well as winners, maintaining good macro policy in an open economy can be politically difficult. 

Martner and Aldunate (2006) estimate that indirect taxes accounted for about 56 percent of total tax revenues in Latin America and 31 percent of tax revenues in Europe in 2003-04. 

Fortunately the increases in the size of the middle class (using my definition) in Mexico and Brazil suggest that the growth the region is now enjoying may be more inclusive than growth has been since the 1970s. 

Reliance on the value-added tax, which is generally regressive, is much greater than in Europe17 (60 vs. 30 percent of total revenue); higher overall and more progressive taxation in Europe reduce income inequality (and probably the burden on the middle class much more than in Latin America). 

7 Barro (2000) in cross-country regression analysis of the determinants of growth finds that the effect of inequality is negative at incomes at or below about $3000 per capita, and positive above that level. 

2. A “fair” tax and redistribution system16Inclusive growth requires not only keeping aggregate spending in line with aggregate revenues. 

The resulting increases in public spending protect the poor and help insulate the middle class while helping to stimulate a sluggish economy. 

In the case of Brazil and Mexico, the slaying of inflation in the early 1990s has made it easier to avoid the overvaluation which for two prior decades hurt exports. 

And countries with high income inequality are likely to have and reproduce two other kinds of inequality: inequality in the distribution of the underlying assets that generate income (land, education, financial wealth), and sufficient inequality in the distribution of political power that education, credit and other public programs fail to compensate for their unequal asset distribution. 

Many such countries are highly dependent on aid, with aid financing as much as 40 percent of all 8 Birdsall (2007), discusses the evidence that high-enough inequality in poor-enough countries inhibits growth. 

One reason may be that the latter countries have hewed less closely than Brazil and Mexico to standard IMF/World Bank macroeconomic policies, and in the case of Venezuela and Ecuador with their dependence on oil exports have been more vulnerable to currency appreciation which tends to be unfriendly to increasing employment and small business development. 

In the case of Brazil, a severely non-inclusive pension system was still costing as much as 3.5 percent of GDP a few years ago21 – equivalent to the lost fiscal space associated with net primary surpluses – and it has been politically impossible to make anything but marginal changes to the system. 

Past fiscal laxity meant governments either printed money, fueling inflation, or issued large amounts of debt, driving interest rates to onerous levels. 

“Redistributing Income to the Poor and the Rich: Public Transfers in Latin America and the Caribbean.” Social Protection Discussion Paper 0605. 

But past high borrowing means that debt service is still high (even taking into account reductions in the debt stock in the last few years) and has to be financed, reducing the scope for new public expenditures (Table 3).