LATIN AMERICA: Middle class faces adverse cha...

LATIN AMERICA: Middle class faces adverse change

As poverty has receded in the face of the sustained economic growth of recent years, Latin America has seen an expansion of its middle class. However, by international standards, this remains small and very vulnerable to new threats such as food-price inflation.

Latin America's unequal income distribution, characterized by a rich elite and the poverty of much of the rest of the population, has historically provided few opportunities for the development of a middle class. In some countries, such as Argentina, the middle class did experience an important expansion in the mid-1900s, partly as a result of the growth of the state and public-sector employment. However, it was badly hit by the region's economic problems in the 1980s and subsequent structural reforms, which involved a reduction in the size of the public sector and the privatization of many state enterprises. Moreover, in Argentina, the middle class was one of the main victims of the country's economic collapse in 2001-02.

New middle class. However, over the past few years, Latin America's middle class has again entered a phase of growth. This has been driven by sustained economic growth since 2004, increased formal employment in the private sector, greater participation of women in the workforce and relatively low inflation.

Promoting middle class development. The existence of a strong middle class is widely assumed to be not only an effect of economic development but also an important contributory factor. In terms of direct impact, its growth creates new business opportunities, particularly in the housing market, retail and financial services. Moreover, countries with a strong middle class -- with its stake in economic and political stability – tend to be less prone to social conflict and the stop-go or populist policies that deter investment.

However, a recent study "The Middle Class and the Development Process" released by the UN Economic Commission for Latin America and the Caribbean (ECLAC) on August 8, suggests that this virtuous circle between the growth of the middle class and a country's economic and political development is contested:

§ Although the study found a close correlation between per capita income and the size of the middle class in high-income countries, this was less clear among low and middle-income countries and the relationship appears to stabilize only at per capita income levels of over 10,000 dollars in PPP terms. That this relationship is not automatic is borne out by the case of Chile. According to the IMF, its per capita income, at 13,936 dollars in PPP terms in 2007, is the highest in Latin America and Chile is also one of the region's most stable countries both economically and politically. However, the share of its middle class in national income is low even by Latin American standards.

§ The study found a clear correlation between per capita income and the strength of democracy. However, a correlation between this latter variable and the size of the middle class was found only for high-income countries and was virtually non-existent in low and middle-income countries.

Policy implications. Rather surprisingly, the study concluded that public expenditure as a fraction of GDP showed little correlation with the size of the middle class. The study suggests that public policies should extend their traditional focus on the poor to include the lower-middle class in order to guard against the drop of its members back into poverty. This is an approach that the Chilean government is considering, following the country's success in reducing poverty, and makes particular sense in a context in which a resurgence of inflation, together with the prospect of slower economic growth and higher interest rates, threatens the progress achieved by this segment of the population in recent years. In April, ECLAC warned that higher food prices could push up to 15 million Latin Americans back below the poverty line