What is ‘middle-out’ economics, and does it stand a chance?

Costco is probably best known for $1.50 hot dogs and generic items sold in bulk. But the US retail chain has also been moving very different items at a steady clip: Rolex watches, diamonds, and bottles of Dom Perignon.

Affluent shoppers may be a surprising element of Costco’s business, but they’re now a stunningly essential prop for the country as a whole. According to a recent analysis, the highest-earning 10% of Americans are doing nearly 50% of all the spending there – up from 36% three decades ago. As the well-heeled shoulder more of the weight of a consumption-heavy economy, spending by middle-class households has declined.

That may be due in part to dwindling numbers. The share of the US population considered middle class has slipped to about 51% from 61% in 1971. In Europe, a recent study found that the middle class has shrunk in nearly two-thirds of EU member states during the past 15 years. Even in Asia, where a surging middle class once seemed like a fixture, there are concerns about whether it will ever recover from pandemic-induced stagnation.

For proponents of “middle-out” economics, this isn’t great news. A truly healthy economy is one with a thriving middle class, they say; enabling more people to buy more things creates a broader foundation to build on.

“People like me can only own so many yachts or airplanes or what have you,” the venture capitalist who helped coin the term “middle-out” economics once wrote. “I earn about 1,000 times the median American income annually, but I don’t buy thousands of times more stuff.”

When Harvard economist Dani Rodrik was recently asked by the Radio Davos podcast to name one thing leaders should prioritize this year, he chose “the health of the middle class.”

“We need a very serious rethink of how we do that,” he said.

Rodrik and others have particular ideas about how to restore middle classes. Instead of struggling to resurrect a manufacturing workforce for modern factories that inevitably require fewer workers, work with reality. And that reality, in many places, is a massive service industry.

Making sure that service-industry jobs are good quality in terms of pay, benefits, and conditions could help restore and expand the middle class, Rodrik says, and foster its consumption.

Yet, the dream of creating multitudes of well-paid workers making durable goods with their hands dies hard.

The previous US administration sought to engineer this with industrial policy. Incentives were offered to build factories staffed with domestic workers. The current administration is aiming, directionally, for a similar thing – but through the use of a multitude of protectionist tariffs.

The last time the country leaned this heavily into tariffs, more than a century ago, it may have created more domestic manufacturing jobs, but it also diminished overall labor productivity. This time, resulting price increases for food and energy are expected to disproportionately impact middle-income earners.

Of course, even if a country does manage to get more manufacturers to set up shop locally, it’s only half the battle. Taiwanese chipmaker TSMC has committed to a multi-billion dollar factory in the US state of Arizona, but it’s also imported about half of its workers from Taiwan. Nourishing a middle class means providing things that are more fundamental than prospective employment, like a technical education.

Proponents have tried just about everything to make their case for a middle-out approach, from podcasts to comic books. Their task seems to be made more urgent every day.

In the OECD, a grouping of some of the wealthiest countries, median incomes increased by a third less than the average income of the richest 10% of people there in the few decades prior to 2019.

Globally, the middle class had been growing at a solid pace, or by about 54 million people every year, starting in 2011. But when the pandemic ground just about everything else to a halt in 2020, that growth also petered out.

Indonesia’s middle class, which had reached a size roughly equal to the combined middle classes of the Philippines, Malaysia, Thailand, and Viet Nam, couldn’t endure; it shrank from 22% of the country’s population pre-pandemic to 17% last year.

In Europe, countries as diverse as Sweden, Bulgaria, and Malta shared significant estimated middle-class declines between 2007 and 2022. The region may now have to shift its fiscal priorities away from social protection in favor of defence, which could further deplete the ranks; in Europe’s biggest economies, according to the OECD, social protection (in the form of things like unemployment benefits) reduces the income instability liable to jettison people from the middle class by 42%.

Despite the odds, some countries have distinguished themselves with efforts to engineer growth from the middle out.

The government in Mexico has more than tripled the minimum wage there since 2018 in a bid to stay ahead of inflation, and mandated an increase in vacation days for everyone working in the private sector. A recent reform of the pension system guarantees retirees payments equal to 100% of their most recent salary.

Mexico’s middle class already outstrips those in more populous countries like Russia, and it’s projected to continue to grow well into the next decade.

The size of Spain’s middle class, which has been closely tied to the country’s broader social cohesion and the functioning of its institutions, has also been expanding. Income inequality there has returned to pre-pandemic levels.

There are some general things any place can aim for if it wants to help people remain in (or join) the middle class. Making use of AI as something that can help people be more productive instead of replacing them seems like one.

Or, bearing in mind that heavy tariffs and protectionism have always impacted low- and middle-income earners hardest, which makes it unlikely things will play out differently now. Particularly at a time of growing disparity, when even billionaires are being outpaced by their superbillionaire peers.

There’s probably no single best approach to anchoring economic growth to middle-class expansion. Whatever label is applied to it, a lot of economists and historians think it’s a good idea.

It’s worth noting the accumulated evidence that the opposite of “middle-out,” usually called “trickle-down,” has undermined any middle class subjected to it for extended periods.

It may also be worth considering that Mexico and Spain were among the few democracies where incumbent parties were not voted out of power last year.