By McKinsey Global Institute

A new McKinsey Global Institute (MGI) report, Urban World: Cities and the rise of the consuming class,analyzes the massive wave of urbanization that is propelling growth across the emerging world in the coming decades. The research expands MGI analysis of the top 2,600 cities globally, including cities’ demographics, household structure, and incomes, and their contribution to activity and growth in different sectors, including buildings construction, port infrastructure, and municipal water supply. Highlights follow.

A wave of urbanization propelling growth across emerging economies is a welcome fillip for a world economy that continues to have pockets of acute fragility. The move to urban living is lifting the incomes of millions of people around the world. In cities, one billion people will enter the global “consuming class” by 2025, with incomes high enough to become significant consumers of goods and services. Around 600 million of them will live in only around 440 cities in emerging markets that are expected to generate close to half of global GDP growth between 2010 and 2025. We are witnessing incomes rising in developing economies faster and on a greater scale than at any time in history (Exhibit 1: NIC Blog – MGI – Urban World – Exhibit 1).

By 2025, urban consumers will inject around $20 trillion a year in additional spending into the world economy. Catering to the burgeoning urban consumer classes will also require a boom in the construction of buildings and infrastructure. We estimate that cities will need annual physical capital investment to more than double from nearly $10 trillion today to more than $20 trillion by 2025, the majority of which will be in the emerging world. How companies and governments react to the fastest shift in the earth’s center of economic gravity in history—will fundamentally shape their future prospects.

The additional consumption and investment that will be part of the urbanization story is a very large opportunity for businesses. But there will be challenges, too. The wave of new urban consumers in the emerging world is already driving strong demand for the world’s natural and capital resources. The global investment rate and resource prices have jumped and could rise further. Cities can be part of the solution to such stresses, as concentrated population centers can be more productive in their resource use than areas that are more sparsely populated. But if cities fail to invest in a way that keeps abreast of the rising needs of their growing populations, they may lock in inefficient, costly practices that will become constraints to sustained growth later on.

Urban growth is highly concentrated in just a few hundred cities and will continue to be. Our analysis suggests that just the top 600 cities by their contribution to global GDP growth to 2025—a group we call the City 600—will generate nearly 65 percent of world economic growth in this period. Today, the City 600 is home to just over 20 percent of the world’s population but accounts for nearly $34 trillion, or more than half, of global GDP. Between 2010 and 2025, we expect the City 600’s combined GDP to nearly double to $65 trillion. But the most dramatic chapter of today’s urbanization story is the role played by the so-called Emerging 440. These emerging market cities in the City 600 will account for close to half of expected global GDP growth between 2010 and 2025 (Exhibit 2: NIC Blog – MGI – Urban World – Exhibit 2).

The incomes of these new consuming classes are rising even faster than their numbers are. This means that many products and services are hitting take-off points at which their consumption rises swiftly and steeply. Growth patterns will vary among products and services for three main reasons. First, as incomes rise, consumers choose where they spend the additional available income, and some products take off at lower incomes than others. Second, products and services vary in the shape of their adoption curve and then in the rate of growth of mature, well-penetrated markets. Third, there are geographic differences in demand for cultural and demographic reasons.

Infrastructure needs will also vary between regions and among different categories. In this research, we focus on residential and commercial buildings, port capacity (due to rising container demand), and municipal water. We estimate that cities will need to construct floor space equivalent to 85 percent of all of today’s residential and commercial building stock by 2025. The capacity of ports to handle urban container traffic needs to rise by more than 2.5 times from today’s level. We expect municipal water demand in cities to rise by almost 80 billion cubic meters, equivalent to more than 20 times the water consumption of New York today and 40 percent above today’s global level.

Again, there will be differences across regions and infrastructure needs.Chinais likely to have a 25 percent share of urban municipal water demand growth and a share of nearly 40 percent of growth in global demand for urban building floor space to 2025. Africa and the Middle East will account for almost 14 percent of the global rise in municipal water demand in large cities, almost twice their share of urban GDP growth. Across all three categories, we expect Emerging 440 cities to account for roughly 60 percent of global demand growth to 2025, although the shares of individual cities will vary.

Differences between the consumption take-off points depending on the product or service underline the need for companies to understand their target markets in forensic detail. The top urban markets in different demographic segments (e.g., elderly higher income consumers; or new young entry-level consumers) as well as for different products (e.g., laundry care) and demand for commercial floor space and municipal water are all different (Exhibit 3: NIC Blog – MGI – Urban World – Exhibit 3). Indeed, on these five “hot spots” for growth, the likely top cities are in three different continents: Shanghai and Mumbai in Asia; Lagos in Africa: and São Paulo and New York in the Americas. So depending on the products they sell, and the segments in which they specialize, companies need to have a detailed knowledge of which cities offer the most promising markets.

Companies that understand the shifting urban marketplaces relevant to their businesses and build a presence early on with sufficient scale are likely to benefit from being the incumbent with better market access and higher margins. Yet, disappointingly, most companies are still not looking at cities as they calibrate strategy. A new McKinsey survey finds that less than one in five executives is making location decisions at the city, rather than the country, level—and respondents did not expect this low share to increase over the next five years. Even those companies that arm themselves with the detailed city-level knowledge to identify the most promising markets for their products then need to allocate resources efficiently and master the art of execution in diverse and rapidly evolving emerging markets.

The challenge for policy makers differs according to whether they are in cities in the developing or the developed world. In a nutshell, the task for the former is to manage growth in a way that avoids diseconomies of scale and builds the basis for sustainable economic performance. For the latter, simply maintaining a healthy rate of growth can be tough, particularly in the aftermath of recession. Many developed cities are aging and no longer attracting migrants. Instead, they have to seek new vigor from higher productivity, new business investors, and enhanced links with the urban dynamos of emerging regions.

The McKinsey Global Institute (MGI) is the business and economics research arm of McKinsey & Company. Its mission is to help leaders in the commercial, public, and social sectors develop a deeper understanding of the evolution of the global economy and to provide a fact base that contributes to decision making on critical management and policy issues. MGI works with leading economists, including Nobel laureates, who act as advisors on its research.