The Role of Middle Class in Economic Development: What Do Cross‐Country Data Show?

• Published date: 01 May 2017
• Date: 01 May 2017
• Author: Muhammad Habibur Rahman,Natalie Chun,Rana Hasan,Mehmet Ali Ulubaşoğlu
• DOI: http://doi.org/10.1111/rode.12265

The Role of Middle Class in Economic

Development: What Do Cross-Country Data Show?

Natalie Chun, Rana Hasan, Muhammad Habibur Rahman, and

Mehmet Ali Ulubasßo

glu*

Abstract

This paper investigates the channels through which the middle class may matter for consumption growth.

Using several different middle-class measures and a panel of 105 developing countries spanning the

period 1985–2013, we find that a larger middle class influences consumption growth primarily through

higher levels of human capital accumulation. There is also a significant direct effect of middle-class size

on consumption growth, which is more pronounced in the latter half of the sample, the 2000–2013 period.

1. Introduction

Do countries with a larger “middle class” grow faster? A number of economists

believe that the answer to this question is in the affirmative. For example, Kharas

and Gertz (2010) compare the growth experience of Brazil and South Korea and

suggest that the differential performance of the two countries can be explained by

differences in the relative sizes of the middle class in the two economies.

1

Why

should a larger middle class help foster growth? Banerjee and Duflo (2008) identify

three arguments that are commonly made. The first argument is that the middle

class is where entrepreneurs that foster innovation and growth emerge from. A

second argument stresses middle-class “values” that encourage accumulation of

human capital and savings. A third argument suggests the consumption power of

the middle class leads to diversification and expansion of markets that allow for the

exploitation of economies of scale in production (see Murphy et al., 1989). In

addition, the middle class may play a key role in better governance, because unlike

the poor, the middle class may have the ability and power to demand better public

service delivery and greater accountability from public officials (Birdsall et al.,

2000). These arguments suggest that the presence of a strong middle class in a

country should have a significant positive influence on economic growth.

Nevertheless, while the middle class is often envisioned to have values,

investments and consumption patterns that differ relative to poor and high-income

classes, empirical examinations have been faced with the challenge of defining and

measuring the middle class. A number of relative and absolute measures have been

*Ulubasßo

glu (Corresponding author): Department of Economics, Deakin University, 70 Elgar

Rd, Burwood, VIC, 3125, Australia. E-mail: mehmet.ulubasoglu@deakin.edu.au. Chun and Hasan:

Economic Research and Regional Cooperation Department, Development Economics and Indicators

Division, Asian Development Bank, Manila, The Philippines. Rahman: Department of Economics,

Deakin University, Burwood, VIC, 3125, Australia. This paper represents the views of the authors and

does not necessarily represent those of the Asian Development Bank, its Executive Directors, or the

countries that they represent. The authors would like to thank Editor Andy McKay and two anonymous

reviewers for their detailed comments. Special thanks go to Anil Deolilakar and Jong-Wha Lee. Glennie

Amoranto provided excellent research assistance.

Review of Development Economics, 21(2), 404–424, 2017

DOI:10.1111/rode.12265

©2016 John Wiley & Sons Ltd

put forward based on per capita consumption measures. However, strong

differences in values are often not found between different economic classes and

especially between middle and upper classes (e.g. Amoranto et al., 2010; Lopez-

Calva et al., 2012). This has caused some researchers to suggest alternative cut-offs

such as low probabilities to vulnerability to define class status. This is based on the

finding that preferences and values of poor and vulnerable groups often differ from

middle and upper classes because of concerns about managing basic needs rather

than being able to focus on future investments (e.g. Lopez-Calva and Ortiz-Juarez,

2014). Others have provided evidence that perceived social mobility is a key factor

affecting middle-class values and behavior (Leventoglu, 2014). Moreover, many

debate the role of middle class in actually demanding better governance through

redistribution and great er public services (Rueschemeyer et al., 1992) with some

arguing that this only occurs when a regime transitions to democracy (Przeworski,

1992) or when social mobility is seemingly more restrictive (Piketty, 1995; Benabou

and Ok, 2001).

This paper seeks to examine the role of the middle class in economic growth in a

cross-country context. Using a structural growth model 

alaMankiw et al. (1992)

and a panel of 105 developing countries covering the period from 1985 to 2013, we

explore whether the middle class is of direct importance to economic growth and/or

has a more indirect effect on economic growth through its impact on factor inputs,

including human capital, savings and labor force growth.

2

Drawing on the debates centered on the definition and measurement of middle

class, our investigation utilizes three different middle-class definitions that are based

on both absolute and relative measures of consumption expenditure. The absolute

middle-class measure, defined as the share of the population living on US$2–$10

per person per day (in 2005 purchasing power parity (PPP) dollars), is similar to

Banerjee and Duflo (2008). It assumes that those living on more than US$2 per day

have a base amount of consumption that can contribute economically to growth.

3

We also examine a relative measure, where the middle class is defined as the share

of households that have consumption expenditures between 75% and 125% of the

median expenditure, as in Birdsall et al. (2000). This concept captures the idea that

the middle class may be important not only for its consumption power, but also

through its ability to form a political or economic action group that demands and

implements policies that can contribute to market-oriented growth. It is related to

the theories of the median voter whose support is often sought in the financing of

productive public investments such as health or education. Finally, we examine

another relative measure used by Easterly (2001), which is defined as the

expenditure share held by the middle 60% of the expenditure spectrum. Examining

a diverse set of middle-class measures can provide evidence for the debate over the

type and notions of middle class that are really important to to economic growth in

a cross-country context.

We focus on developing countries for two reasons. First, the definition of middle

class varies across developing and developed countries. Income groups defined as

middle class in developing countries may belong to the poor class in developed

countries. For instance, Ravallion (2010) argues that while people living on US$2–

$13 per day can be treated as middle class in developing countries, they would be

treated as poor by US standards. Second, the growth path and factors that matter

to growth in developed countries are expected to differ fundamentally from the

growth path and factors influencing growth in developing economies. Including

developed countries in the sample makes sense for growth studies which use data

ROLE OF MIDDLE CLASS IN DEVELOPMENT 405

©2016 John Wiley & Sons Ltd