One portfolio manager warns against a popular misperception about what drives growth in emerging-market countries
There are many reasons for investors to believe in the promise of emerging markets. One of the most well-known involves the rise of the middle class, which in theory creates a bigger base for consumption as wealth gaps narrow and discretionary income swells. But according to one commentary, the generally accepted narrative is closer to myth than truth.
“In reality, upward social mobility and the emergence of a middle class in EM has been largely confined to China over the past decade,” wrote Justin Leverenz, senior portfolio manager at Invesco in the US. “’Companies, not countries,’ we contend, is the narrative that should drive investment in emerging market equities.”
The problems with the EM middle-class narrative, Leverenz said, begin with the simple definition of “middle class.” Because of the heterogeneity across EM economies in terms of income distribution and inequality, he said, “[t]here is simply no authoritative way to develop consistent estimates.” Countries like Qatar and the United Arab Emirates distort the picture with their small populations and wealth of hydrocarbons. Some East Asian countries with strong manufacturing bases, he continued, can be considered closer to developed nations.
“While people often look around the emerging markets for a repeat performance of China’s economic boom, in reality the overarching theme of a broad, rising EM middle class scarcely exists,” Leverenz said. Most outsized gains within the EM middle-class population were registered in China and India, along with a handful of Asian countries like Vietnam, South Korea — which is arguably too rich to count as an EM nation — and the Philippines. Larger EM countries including Russia, Brazil, and Mexico, he added, have seen just a slight uptick in middle-class growth relative to total population over the past two decades.
And while many might think India would follow in China’s footsteps toward a middle-class expansion and economic boom, Leverenz expressed doubts. Such a demographic expansion, he explained, requires a rare coincidence of faster economic growth and falling income inequality. Aside from the modest assets held by the country’s middle class, the wealthy are truly wealthy; India hosts over 200,000 millionaires. That’s created a lacklustre picture of per capita GDP growth underpinned by a dual-track economy.
A similar situation can be seen in Mexico, where an oligopolistic structure has put a rising concentration of wealth in the pockets of a few families. “The top 10 Mexican families account for more than a fifth of its total stock market value3 – one of the highest concentrations throughout EM,” Leverenz said.
And while Brazil showed signs of shedding its reputation for socioeconomic inequality in the 2000s, he noted that the share of the middle class peaked in 2011 at 33%. Since then, the trend has reversed dramatically with the middle class making up less than 22% of the total population.
“The issue of the ‘squeezed middle’ is mirrored in other large EM countries such as South Africa, where the middle class as a share of total population has shrunk from 22% in 2011 to around 16% in recent years,” Leverenz said. And while a host of Southeast Asian countries have an opportunity to compete for labor-intensive, manufacturing-led export growth, they’ve largely shown anemic growth in terms of the middle class as a share of national population.
