The rising importance of the middle class in India

March 31, 2021 6:00 AM

India would soon have a middle class that is proportionately as large as that of the US today. The government is unlikely to be able to provide the quantity and quality of services that will be demanded, even in areas like health, education and water that have evolved as public-sector areas in other countries. India will have to adopt hybrid systems, with private and public service providers

The emergence of a large bulge of population out of absolute poverty, and poised to enter the middle class, would create a new dynamics.

By Ejaz Ghani

The middle class is claimed to be the ‘bird of gold’. Is India’s rising middle class an engine of growth or a loose wheel? Are they associated with social progress—freedom of press, education and gender equality? A massive shift towards a middle class society is already happening in India. Our empirical investigation shows that the rising middle class is both a causal factor behind India’s improved economic and social outcomes—growth, education, home ownership, and social security—as well as a consequence of the rise in the middle class.

Growing size of the middle class

India’s favourable demographic trends, which have raised the proportion of the workforce in the total population, have set the stage for a massive expansion of the middle class. The emergence of a large bulge of population out of absolute poverty, and poised to enter the middle class, would create a new dynamics. While recognising the multidimensional nature of the middle class, we combined microeconomic household survey data with macro data to quantify the growing size of the middle class (see Ejaz Ghani and Homi Kharas, Reshaping Tomorrow and The Rise of the Middle Class; https://bit.ly/3w8AIUB).

Nearly 55% of the Indian population is expected to join the ranks of the middle class. In fact, because India’s demographics are much younger compared to China and the US, India’s middle class could be the largest in the world (in terms of numbers of people) by 2025. It is not an exaggeration to say that future growth will depend on the rising middle class, and the evolution of the middle class will depend on growth.

It is both private consumption and saving, fuelled by the middle class, which has driven growth. Private consumption in India is almost 60% of the gross domestic product (GDP), and private consumption growth has accounted for 70% of Indian growth since 2000. Even though China’s middle class is currently larger than that of India, the former’s private consumption accounts for a smaller fraction of growth. Unlike the US, where domestics savings are declining—and it borrows surplus saving from abroad, in order to invest and grow—India’s domestic savings and investments are on the rise and are financing investments.

The growth of the middle class is likely to be associated with a gradual shift from large-scale informality that characterises much of the services and manufacturing sectors today, to more formal, wage-earning and medium-scale businesses. Technological advances will spread more rapidly. Cities will grow as job opportunities cluster there. The spread of growth across the population will be broader, if there is sufficient migration between states and from rural to urban areas.

Expanding role in economic growth and social progress

While it is clear that growth can create a middle class, the reverse is also true, and a large middle class can help sustain growth. The middle class has played a special role in economic thought for centuries. Emerging as the bourgeoisie in the late 14th century, while derided by some for its economic materialism, it provided the impetus for expansion of a capitalist market economy and trade between nation states. Ever since, the middle class has been considered a source of entrepreneurship and innovation, setting up small businesses that make a modern economy thrive.
There are four key contributions that the middle class makes to economic growth and social progress. First, the middle class is a source of entrepreneurship. It is often claimed that small businesses and family farms—the heart of the middle class—made America great. Second, the middle class is a major contributor to savings and human capital, as savings rates and the willingness to invest in human capital are higher amongst middle class households. Third, they strengthen the links with the democracy, free press, education and fair elections.

The fourth channel that makes the middle class special relates to consumption. The expanding demand for consumer durables—cars, motorcycles, televisions, air conditioners, mobile phones and refrigerators—is already leading to an acceleration in manufacturing in India. The middle class is also demanding housing, shopping malls, and other infrastructure, and can afford to take an annual vacation, boosting domestic tourism. The middle class saves for its own retirement, housing and children’s education, providing the resources for fixed capital formation, especially when there are two-income families. In short, most examples of rapid sustained economic growth coincide with the development and expansion of the middle class.

As industrialisation has fixed costs, and because international trade is costly, there must be a domestic market of a certain size to overcome these costs. The domestic market, in turn, is a function of the number of people with sufficient income to buy a product. Once the size of the middle class passes a threshold size, a virtuous cycle is initiated: a bigger middle class spends more, leading to higher business profits, savings and investment, higher growth, and a larger middle class.

There are many reasons to be optimistic about India’s future growth that will be driven by the rapidly rising middle class, young demographics and the next wave of globalisation. The middle class tends to be is well-educated, enterprising, innovative. Unlike traditional models of export-led growth based on industrialisation, India has already marched ahead with a services-led growth, as technological progress has made services more tradable. Growth in Asia is strengthening, and India will benefit from neighbourhood effects—the fastest growing markets will be closer to home.

India would emerge with a middle class that is proportionately as large as that of the US today. Empirical evidence, based on India’s household surveys, changing demographics and favourable trends in urbanisation, show that a massive shift towards a middle class society is already in the making. The precise numbers are less relevant than the trends—and those seem to be strong at present.

Almost a billion people will join the ranks of the middle class by 2025, if India can expand investments in physical and human infrastructure, declare independence from the virus, spur rural vitalisation, and reduce inequality. The government is unlikely to be able to provide the quantity and quality of services that will be demanded, even in areas like health, education and water that have evolved as public-sector areas in other countries. India will have to adopt hybrid systems, with private and public service providers. This can be achieved if India can push for an increase in lending by global and regional multilateral institutions. There is a huge potential, for example, to push for a large issuance of Special Drawing Rights, the International Monetary Fund’s reserve asset.

The author has worked for the World Bank, and taught economics at Delhi University and Oxford University

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