China’s Missing Middle Class – Analysis

 By: FPIF

May 27, 2012

By Nan Chen

Two parallel narratives surround globalization and the trade imbalance between China and the United States. One side moans that competition with China has squeezed traditional U.S. manufacturing jobs and caused the middle class to disappear. The other side declares that a new Chinese middle class is riding the wave of China’s inexorable economic boom. A particularly hyperbolic headline in Forbes, for example, proclaimed the rise of China’s middle class to be “The Biggest Story of Our Time.”These statements are oversimplifications of a complicated relationship. Although the U.S. middle class has been squeezed and manufacturing has been outsourced to developing nations such as China, there has not been a corresponding rise in the Chinese middle class like that seen in the United States after World War II. Manufacturing jobs in the United States created a distinct middle class in the post-war years, but these now outsourced jobs do not appear to engender the same affluence in China.

China

Rather than a middle class of laborers in the manufacturing industry, China has seen disturbing levels of income inequality and the emergence of a new “elite” class at the same time that the United States is experiencing similar shifts. This has implications not only for China’s growth, but also for U.S. exports that stand to benefit from a healthy Chinese middle class of consumers. Moreover, the growing wealth disparity in China suggests that China’s embrace of free-market economics and unfettered globalization may result in the same social ills seen in the United States.

The Disappearing U.S. Middle Class

After World War II, the United States saw unprecedented and unreplicated growth stemming from the factories mobilized by war, suburbanization, and high consumption. Moreover, this growth was spread relatively equally among all sections of society. Mass production supported this economy as American workers, returning from the war and bolstered by federally funded job training and education, filled the factories and received relatively high wages. This meant that not only did the United States have a large manufacturing class; it had a large manufacturing class with disposable income – a consumer class. The cycle of high wages and high consumption spurred economic growth and prosperity.

However, the American middle class has shrunk in the past 30 years while income inequality has steadily grown as a result of both consumer and investor demands. Companies must balance the combination of competitive pressures, investors seeking to maximize returns on capital, and consumer demands for lower prices. In this balancing act, middle-skill workers tend to lose out. For example, in 2006, when the profitable Caterpillar, Inc. came under pressure from investors for higher earnings, new employee wages and benefits decreased by nearly $20 an hour. Caterpillar group president Douglas Oberhelman remarked soberly, “there is a balance that must be struck between being competitive and being middle class.”

Studies on income inequality in the United States have shown a hollowing out of the middle class. For example, between 1970 and 2001, CEO pay increased from roughly 30 times to 350 times as much as the average income; the popular Piketty and Saez studies conclude that the top .01 percent of earners’ income share rose dramatically from 0.5 percent in 1973 to roughly 6 percent by 2007; and the Economic Policy Institute found that income for the top fifth of earners grew by 49 percent between 1979 to 2009, compared to an increase of only 11.2 percent for the middle fifth and a loss of 7.4 percent for the bottom fifth. In conjunction with the low cost of wages and technological advances, globalized supply chains and cheap manufacturing provided another fix to the demands for cheaper, more profitable goods. Companies under constant pressure to reduce costs found an answer in overseas manufacturing.

Thus, it is little wonder that the United States has seen a precipitous decline in manufacturing jobs over the past 30 years. The New York Times recently published an article bemoaning the inexorable outsourcing of manufacturing jobs to China and other developing nations. While this will be cold comfort to those in the Rust Belt, optimists counter that the loss of jobs in the United States is balanced by the immense gains in developing nations. In other words, outsourcing represents a global rebalancing in which developing nations can now attempt to catch up to the more developed countries by underpricing them in goods and services. Although this view may hold some truth, evidence in China does not suggest the creation of a middle class of consumers similar to that of the post-war United States, nor does the evidence support the fast-paced rise of this class.

The Rumored Chinese Middle Class

Rumors of a rising Chinese middle class have been touted widely. However, the evidence supporting these claims remains conflicting at best. The “middle-class” jobs outsourced from the United States have not necessarily translated to “middle-class” jobs in developing nations, especially in China. Defining the middle class has always been a difficult venture, but on several fronts the Chinese middle class remains nascent.

Using wages as an indicator, the manufacturing jobs in China fall far short of providing a middle-class lifestyle. The China Daily reports that the average manufacturing wage in Shanghai in 2008 was 42,311 yuan ($6,723) annually, the highest in the country. The same article also listed annual wages in other parts of China (excluding Beijing and Shanghai, where the cost of living spikes) at roughly 19,500 ($3,098) to 25,000 yuan ($3,972) annually. Even in Shanghai, these wages are below middle-class.

A 2005 study conducted by the State Statistics Bureau of the Chinese government used an income range of 60,000 ($9,534) to 500,000 yuan ($79,444) for a three-member household as the primary determinant of middle-class status. This report places factory workers at far below middle-class status, or possibly at the bottom, for a two-income household, and calculated only roughly 20 percent of the Chinese population as middle-class (to be sure, this report has received some criticism by Cheng Li of the Brookings Institute). And while wages are rising, they won’t reach middle class wages any time soon. For example, Foxconn Technology, which makes an estimated 40 percent of the world’s consumer electronics, recently raised its wages to about 2,200 yuan per month ($350) after a rash of suicides and bad press. Even at these increased wages, workers lack the human capital, access to healthcare or education, and consumer behavior that are generally indicators of a middle class. Moreover, the salaries at Foxconn are likely higher than other manufacturers that are less assiduously monitored by the press. Migrant workers, many of whom work in these “outsourced” factories, averaged about 1,690 yuan ($266.86) per month in income.

Perhaps a more important indicator of middle-class status is consumption behavior. A rising consumer class in China would drive economic growth and could also balance some of the trade deficit with the United States. The emergence of such a class would augur well for China’s purported goal of transforming its industrial manufacturing economy into a knowledge and services economy. However, a 2010 OECD report using consumption as an indicator found that the Chinese middle class constituted only 12 percent of the population. This is simply not large enough to drive the shift from a manufacturing-export economy to an innovation economy.

The absence of a substantial consumer class in China is particularly significant for the United States, because this consumer class presumably would demand U.S. goods. But since China’s entrance to the World Trade Organization in 2001, U.S. companies have been disappointed by the lack of consumer spending in China. In recent years, although exports of certain products like computer components, automobiles, grain, and chemicals have seen an encouraging rise, the U.S. trade deficit with China remains high at roughly $272 billion. Thus, looking at consumption, the explosive growth in the past 30 years has yet to create a significant middle class.

China still has a long way to go before it can claim a legitimate middle class capable of driving healthy economic growth through its own consumption, rather than relying on exports to other countries.

China’s New Elite

If China has been experiencing near double-digit growth in GDP yearly but has yet to see a robust middle class, where has all the growth gone? In fact, rather than creating a new middle class in China, outsourcing has contributed to the rise of a new elite class. It appears that the disproportionate benefits of China’s near 10-percent  annual GDP growth over the last 30 years have fallen on a minority elite (not entirely unlike the current situation in the United States). Though growth has benefited all Chinese citizens to some extent, wage inequality has exploded. China’s Gini coefficient (a measure of inequality) has increased to roughly 45.3, approaching levels of dangerous inequality (compared to the U.S. score of 46.8 in 2009). Thus, rather than replicating the middle-class growth of post-World War II America, China appears to have skipped that stage altogether and headed straight for a model of extraordinary productivity but disproportionately distributed wealth similar to the contemporary United States.

At the same time that the United States was responding to the oil and stagflation shocks of the 1970s accompanied by growing globalization, China was responding to the devastations of the Cultural Revolution. Since the late 1970s, both countries have pursued similar market-oriented economic policies, which appear to have resulted in wage inequality and the absence of a robust middle class in both countries.

China’s “rising” middle class remains nascent and tiny as a share of total population. In order to have a true middle class capable of driving economic growth, China must increase this population several-fold, reduce income inequality, and increase consumption. Otherwise, it will not be able to transform from a commodity export economy to an innovation economy. Likewise, if the Chinese middle class never materializes, then the United States will have lost an opportunity for growth in its own exports. The arrival of a new elite class in China does not come from the throngs of factory workers, but more likely on the backs of those workers.

Recovering The Middle Class

This is not to say that a middle class in China will never rise, or even that it may not appear in the next few decades. However, under the current policies, the emergence of such a class is less likely than the media suggests. There are no easy solutions for reinvigorating the American middle class in a post-industrial economy, or for creating such a class in China.

However, the United States can create a new middle class of skilled and well-compensated workers capable of driving innovation and production by enacting appropriate economic policies such as eschewing protectionist policies that prop up failing industries, increasing federal funding for education and addressing poverty-related achievement gaps, incentivizing innovation through subsidies, and, to the extent that manufacturing occurs domestically, focusing on high technology like computer components (which have seen a rise in exports to China). These workers will also be consumers that can purchase products designed and perhaps even manufactured, at least in part, in the United States. At the same time, a more robust middle class in China will also purchase more U.S. goods.

The middle classes of China and the United States are inextricably linked. The United States need not fear the rise of China’s middle class but should see it as the rise of a billion consumers and an opportunity to meet those consumers’ demands. However, despite the claim of optimists in the media, the verdict is still out as to whether China’s growth will create a robust middle class or just income inequality.

 China’s Missing Middle Class – Analysis.

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