Future generations may well look back to the present and agree that, with the benefit of hindsight, the 2020s were a major turning point for the world. For nearly eight decades since the end of World War II, humankind had enjoyed relative peace and order, fostering an environment that was conducive to investments, trade, economic development and growth, and prosperity. Sure, there were regional conflicts across the globe (in Europe, Asia, the Middle East and Africa) and recessions, some more severe than others, but throughout this period, the global economy continued on its upward trajectory.
Notably, it was an unprecedented period for inclusive growth and upward social mobility. In the developed world, the middle class soon accounted for the majority of populations — there was broad wealth accumulation and people saw tremendous improvements in their standards of living. Americans born in the 1940s had a more than 90% chance of earning more than their parents. This era of American consumerism became the driver of global growth after World War II, the fruits of which then trickled through the developing world and, in particular, Asia, in the ensuing decades.
Through increasing globalisation, the rest of the world embraced key aspects of Western liberal democracies, the best practices and governance models, open economies and trade, and, critically, the transfer of knowledge in science and technology. Hundreds of millions of people were lifted out of poverty worldwide, progressing to the aspiring middle class and middle-upper middle class. China was the biggest contributor to this feat, reducing the number of poor by nearly 800 million in the last 40 years of economic transformation.
The middle class is the consummate consumer, with the purchasing power for discretionary spending — on entertainment, travels, consumer goods and affordable luxuries — as well as for better education and healthcare, plus leftover for savings and investments. The growing ranks of the middle class are, and will continue to be, the biggest demand driver in the global economy. The wealthy have low marginal propensity to consume, that is, a larger proportion of additional incomes will be saved. The poor, on the other hand, spend a high proportion of their incomes on the necessities of life, for housing, food and transportation. There is little income remaining for discretionary consumption.
The Covid-19 pandemic in 2020 was a defining event in our lifetime, the first truly global pandemic, affecting every country in all corners of the world. It caused a major setback in terms of living standards of the people, especially in the developing world. According to a Pew Research Center analysis (based on World Bank data), the global upper-middle and middle-income classes had 90 million fewer people in 2020 compared to pre-pandemic projections while the number of low income and poor increased by some 152 million.
While the poor are most often the focus, and recipient, of government aid, it is the global middle class that is now under immense pressure, from rising cost of living and imminent recession in the near-medium term. Even more worrying is the fact that the world is moving towards a future of greater unknowns and, likely, upheavals.
There are longer-term fallouts from the pandemic, including structural shifts we highlighted a couple of weeks ago in this column. The ongoing war in Ukraine, the largest conventional military confrontation since WWII, has no end in sight — and is adding to the pandemic-driven supply disruptions, due in large part to Western sanctions. The result is rising energy and food prices, and the highest inflation since the early 1980s. In the worstcase scenario, the war could turn nuclear.
At the same time, increasing geopolitical contestation appears inevitable, most notably between the US and China, and their respective spheres of influence. We explained why this is so last week (see “IT and biotech are the battlegrounds to determine future global dominance”, The Edge Singapore, Issue 1055, Oct 3). Cooperation between nations is breaking down at a time when we need to work closer together, to tackle the global challenges of climate changes and future tech disruptions. The economic consequences will be huge. It means higher trade barriers and costs, and lower efficiencies — leading to prolonged supply constraints, and that will keep inflation higher for longer. Again, there will be a significant impact on the rest of the world — and, in particular, developing countries.
In short, the unprecedented era of cooperation and globalisation has ended. And with it, we think, the golden decades of more inclusive growth — reflected in the expanding middle class — and broad-based wealth creation (accumulation). Many existing middle-income households may already be in trouble, including in the West. It does not mean that social mobility is over — the population of middle class will continue to grow, notably in India and Asean. But we think the pace will certainly be much slower than it had been in the last 30 years.
See also: Education was, is and always will be the great equaliser
The rise and fall of the middle class in the US
Last week, we explained how innovations from advancements in science and technology during the industrial revolutions super-charged productivity gains, economic growth and wealth in the Western world. The Roaring Twenties was a decade of modernism, urbanisation and rapid economic growth and a time of immense prosperity. But it was also notable for the large gap between the rich and the working class, fuelled by the booming stock market. Inevitably, the bubble burst in the worst stock market crash in history, in 1929, and heralded the start of the Great Depression.
The rise of the middle class in the US did not happen until after WWII up to the 1970s, made up largely of the baby boomer generation. This was the era of broad-based inclusive growth, thanks in part to expansive social programmes under President Franklin D Roosevelt’s New Deal with America. There were massive public investments in education and training, public infrastructure, transportation, utilities and housing as well as for social security. Regulations were introduced for the private sector, banking system and stock market. Protection for workers, minimum wage and a high degree of unionisation ensured that wages growth closely matched increases in productivity. A great number of jobs were created, which supported mass purchasing power and consumerism, and the majority of Americans benefited from the industrial revolution innovations, further driving the industrialisation boom in a positive feedback loop.
The early 1940s was a period of high absolute income mobility — you are almost guaranteed to be better off than your parents, no matter your beginnings or level of education. Social mobility and equal opportunity were at the peak, which has never again been seen. Income mobility started a steady decline, falling from 92% for the 1940 cohort to just over 60% for those born in 1970. It has since fallen even further (see Chart 1).
The fortunes of the middle class took a turn for the worse in the 1970s. This was due, in part, to slower US GDP growth, which averaged only 2.7% a year from 1970 to 2019, down from about 4.4% a year from 1950 to 1969. According to a study (undertaken by academics from Stanford University, Harvard University and the University of California Berkeley titled “The Fading American Dream: Trends in Absolute Income Mobility Since 1940” [Equality of Opportunity Project]), however, counterfactual scenarios indicate that lower GDP growth accounts for only 29% of the decline. The study found that the growing inequality in the distribution of growth in the country was, in fact, the larger reason behind the drop in income mobility. Real wage gains started diverging lower from productivity growth around the 1970s and have been widening ever since. In other words, the share of income for labour fell, while that for capital rose — as wage growth consistently lagged corporate profit expansion (see Charts 2 and 3).
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According to a recent Pew Research Center analysis of government data, the middle class in the US has been in decline every decade for the past 50 years. The share of adults who live in middle-class households fell from 61% in 1971 to 50% in 2021. While more people moved up to the upper-income class (to 21% from 14%), more people also fell into the lower-income group, which now accounts for 29% of the total adult population, up from 25% in 1971. This is a sure sign of rising inequality.
Based on this trend, the middle class will, very soon, no longer form the majority in the US. We have previously written about how inequality affects social mobility, favouring the rich and working against the poor. This is corroborated by results from another study (see Chart 4). Since the baby-boomer generation, each new generation has seen its chances of moving up to the middle class drop. So, what happened in the 1970s that triggered the secular decline of the US middle class?
What happened post-1970s?
President Richard Nixon abandoned the gold standard under Bretton Woods in 1971. The world transitioned to a pure fiat money international monetary order, which provided the necessary flexibility and liquidity to drive global trade and finance, and economic growth. It led to increasing financialisation of the US economy. The financial sector grew exponentially, making up a larger and larger share of the economy, leading to more concentrated wealth — and, with it, political influence.
Milton Friedman’s essay “The Social Responsibility of Business is to Increase Its Profits”, published in 1970, influenced generations of corporate leaders and politicians. Corporates took this as licence to prioritise profits and maximise shareholder value, at any costs. Over time, public policies led to greater deregulations for industries, allowing the rise of Big Business, which weakened worker protections and bargaining power. Tax structures increasingly favoured corporates and the rich.
Recall that we wrote about the third industrial revolution in the 1970s last week — the growth in electronics, communications, IT and computers, and partial automation in production — that extended through the internet revolution in the 1990s. New technologies enabled companies to enhance the logistics of supply chains, permitting even more specialisation and, with container shipping, allowed production to go global.
Two significant political events occurred — the collapse of the Soviet Union, from around 1986 to the end of the Cold War in 1991, and market reforms and opening of China. These brought about a massive integration of cheap labour from central and eastern Europe — and, importantly, nearly one billion Chinese (population in 1980) — into the world economy.
The golden age of globalisation, the biggest driver for incomes and wealth
Under the leadership of Deng Xiaoping, China’s economic reforms and open-door policy, launched in December 1978, brought massive inflows of foreign investments and fuelled entrepreneurship in the country. In 40 short years, it gave rise to the single-largest uplift of the middle class in history. As we said earlier, nearly 800 million Chinese were lifted out of poverty and the country successfully eradicated extreme poverty. Per capita income increased nearly fivefold from 1980 (US$195) to 2000 (US$959).
China’s accession to the World Trade Organization in 2001 was a high-water mark for the world — the biggest symbolism of globalisation. It was probably the single-largest contributor to the creation of wealth worldwide (and lowering global prices of goods). Chinese per capita income increased by a whopping 13 times from 2000 to 2021 (US$12,556). It is now classified by the World Bank as an upper-middle-income economy. Today, 65% of its population live in cities, up from less than 20% four decades ago, when most were growing barely enough food to feed their own families. Its embrace of Western technology and science spurred innovations and, in some areas, China has not only caught up but surpassed the West, including in communications (5G wireless network, rural broadband access and smartphones), digital payments and e-commerce, smart industrial manufacturing and renewable energy (electric vehicles, charging infrastructure, battery technology, solar and wind power).
The confluence of all the above factors led to the golden age of globalisation. It drove rapid economic growth and urbanisation in developing countries. Incomes rose, extreme poverty fell precipitously, as did child mortality. Living standards improved, with better access to education — literacy increased — and healthcare. According to World Bank data, more than 1.3 billion people were minted into the middle class over the last 30 years, the majority in Asia.
The world as a whole made significant gains. But it also drove inequality in the US (and most developed countries). Since capital flow has far less friction than labour, corporates made huge profits by outsourcing production to emerging countries with cheap labour. China became the world’s factory. This, coupled with increasing automation with tech innovations, led to deindustrialisation and big losses in manufacturing jobs across a wide swathe of the US economy and weaker bargaining power and wage growth, especially for low-skill workers. Labour’s share of national income fell while that of corporates grew.
Trade and the internet revolution drove down prices and inflation and, in turn, interest rates, which stayed near zero for much of the past 10 years. Cheap borrowings and lower taxes further boosted corporate profits. Low inflation also allowed the US Federal Reserve to experiment with extreme monetary policies, including quantitative easing (QE), in response to the global financial crisis and Covid-19 pandemic. The Great Recession devastated millions of US households but bailed out the financial sector, whose profits recovered all lost ground in less than three years.
Robust profits — increasingly spent on share buybacks and dividends instead of reinvested in productive capacity — and massive liquidity from QE fuelled the stock market boom. While 56% of American adults own stocks, ownership is concentrated at the top. The top 1% and 10% wealthiest own 54% and 89% of stocks and mutual fund shares respectively, according to a Fed report in 2021. Baby boomers collectively hold 55% of stocks while millennials hold only 2.5%. In short, rich America became much richer while the rest suffered.
Middle class and broad wealth creation will be increasingly harder to achieve
We highlight the US because it is so far the world’s first and largest consumer economy to be driven by the middle class — and also because of data availability. The decline of middle-class America is worryingly because we are also seeing a similar rise in inequality globally. Chart 5 shows the same trend of the top 10% gaining in share of national income, at the expense of the bottom 50% in developed Asia and China.
The world needs to reduce the current imbalance between the rich and the poor, and expand the middle. A robust and growing global middle class is the biggest driver for consumption that will underpin future economic growth and prosperity. As we have shown above, however, middle-class households in the US — and across Europe as well as Asia, including our home, Malaysia — are under immense pressure with rising cost of living.
Unless addressed through progressive policies and more effective redistribution of wealth, inequality — real or perceived, because human emotions and feelings are always relative — will lead to widespread social unrest, political instability, rebellion and revolution. We have seen this play out countless times in history, in both the developed (the rise of populism in Europe, Brexit and the Trump presidency) and developing worlds.
This is, at very least, part of the reason that is driving China’s “common prosperity” agenda, promoted by President Xi in 2021 — to rebalance the social and economic inequalities of capitalism, particularly as GDP growth in the country is expected to downshift. It is the, unsurprising, next stage of China’s transformation, a follow-up to Deng’s “let some get rich first” impetus four decades ago. There is, we think, no better time.
Many secular trends driving global wealth in reverse
So much in the world is changing, reversing many of the secular trends that have supported the rise of the global middle class in the past decades. We fear the golden age of broad-based wealth creation and accumulation is over for the aspiring lower-income class. Attaining middle-class status will be far more challenging.
Current high energy and food prices will disproportionately hurt poor countries — as will the aggressive monetary tightening by the Fed. There will be no let-up, as we explained in our article two weeks ago. US dollar strength is exporting inflation to the rest of the world and raising the risks of debt-financial crisis in developing countries, which could have lasting harm.
The Fed will force a recession in the US to regain control over prices, which we think will turn out to be deeper for everyone else, many of whom have yet to recover from the pandemic and do not have the benefit of government largesse. Recession in the near-medium term will slow upward income mobility and, worse, tip some households back into poverty, in developing countries.
Longer-term growth prospects, too, are less certain today. The era of unprecedented cooperation and globalisation, which has worked so successfully to lift incomes and wealth for both the developed and developing worlds, is now in reverse.
Geopolitical tensions are rising — last week, we explained why the US-Sino tech war would inevitably intensify— and pandemic-driven supply disruptions have exposed the risks of complicated-long global supply chains. The Russia-Ukraine war demonstrated the West’s willingness to weaponise the US dollar, trade and investments. We are certain many will now reassess their dependence on the greenback, Western financial systems and capital markets, and trade. It will lead to more fractured global ecosystems and, maybe, accelerate the decline of the US dollar hegemony. The grossly inequitable distribution of Covid-19 vaccines it likely to have a long-lasting impact on relations between the rich and poor worlds.
We will, therefore, see more protectionism and trade barriers, increased focus on self-sufficiency, national security and supply chain resilience, shifting alliances in the sourcing of goods and services as well as reshoring and friend-shoring production. All these would translate into increased cost inefficiencies and lower productivity, at least for the foreseeable future. They will prolong supply constraints and lead to higher-for-longer inflation, reversing the secular trend of declining inflation (and interest rates) since the 1980s.
Historically, ownership of — along with rising prices for — properties has been one of the biggest drivers for mass wealth creation, owing to their comparatively wide own ership. For instance, while the wealthiest 10% of Americans hold 89% of stocks and mutual funds shares, they own just 45% of real estate. Increased equity values in houses represent windfall gains, boost consumption and economic growth. This path, too, will be increasingly harder to replicate. House prices have outpaced income growth over the past 20 years, making homes increasingly unaffordable to the masses (see Chart 6).
Affordability will drop further in a higher interest rate environment. Existing homeowners, too, will suffer from rising monthly debt servicing charges — for those with variable rate mortgages — eating into disposable incomes. Higher and higher property prices — and rentals — in the long term serve only the interest of the few (rich) and not the majority.
The next stage of growth for the global economy will be driven by productivity gains from the fourth industrial revolution — where the physical, digital and biological worlds converge — amid ageing populations in the West and parts of Asia, including China. We have no doubt that humankind will benefit enormously from future innovations, just like we did from previous industrial revolutions. The new opportunities and economic gains will be immense. So will the disruptions.
What happens when cheap labour — the biggest competitive advantage of emerging countries — is no longer needed to produce goods that can be mass customised and 3D-printed in the future? How will these countries lift their populations from lower income to middle income? What would be the new economic development blue-print to attract investments if the export-driven model becomes obsolete?
With advancements in infotech and biotech, no human job will be absolutely safe in the future digital world. Increasingly, automation and robots will replace human jobs, not just on factory floors and for repetitive administrative processes but also in consumer-facing services and professions such as doctors, lawyers, fund managers and drivers. It is already happening right before our eyes. Rich countries would most probably gravitate towards redistribution of the resulting economic wealth into some form of universal basic income for their populations. But what of the poorer nations that will be left behind in the tech race? Are we destined for a future more prone to conflicts, when aspirations turn to frustrations?
The Global Portfolio gained 1% for the week ended Oct 5, less than the MSCI World Net Return Index’s 2.6% gains. This is due, in part, to our high cash holdings, which will buffer stock declines but also limits gains. Alibaba Group Holding (+12.7%) and DBS Group Holdings (+3.3%) were the two gaining stocks while Apple (-2.3%), Yihai International Holding (-1.7%) and Guangzhou Automobile Group Co (-0.2%) ended lower for the week. Total portfolio returns since inception now stand at 16%, trailing the benchmark index’s 29% returns over the same period.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
