What tells us more about prosperity: Consumption or GDP per head?

Although urban residents, on average, have higher consumption spending than their rural counterparts within each state, there are instances where the average rural resident in some states outspends the average urban resident in other states.
Although urban residents, on average, have higher consumption spending than their rural counterparts within each state, there are instances where the average rural resident in some states outspends the average urban resident in other states.

Summary

  • As a state-wise comparison shows, output data could offer a misleading picture of the standard of living among people at large.

Maharashtra and Rajasthan are among India’s large states in terms of population. The former is also among the most prosperous, with its economic growth driven by the services sector, primarily financial and IT services. The state accounted for over one-third of all direct tax collections in the country and around 15% of the GST mop-up last fiscal year. Rajasthan is an average state in terms of its per-person income, going by average real state net domestic product (NSDP); its real NSDP is about 63% of Maharashtra’s. While the state has raised its economic growth, its performance has not been consistent. Since Maharashtra’s average income level is higher, one might assume its average consumption levels would also be higher than Rajasthan’s.

However, as per recently released data on household consumption expenditure for 2022-23, nominal as well as real spending (adjusted for inflation) per person in rural Rajasthan was higher than in rural Maharashtra. In fact, it was well above India’s rural average. Similarly, Gujarat, another leading state based on per-person income, does worse than Rajasthan in terms of average rural consumer spending. Even in urban areas, per-person spending in Maharashtra was not all that much higher than in Rajasthan. It was just around the national urban average. What explains such a contrast between per-person income (with per person real output as proxy) and real consumption spending (adjusted for inflation)?

If the above comparison included the value of state welfare transfers, differences in such provisions would explain gaps. But the comparison excludes government transfers. Why, then, have richer Indian states shown lower consumption spending per person, especially in rural areas?

Let us examine the likely reasons.

First, real NSDP may not be a good gauge of prosperity per person. It measures output, or gross added value, which is distributed between labour and owners of capital. If the share of labour income in gross value added is relatively low and falling, then per capita output would exaggerate the state’s average prosperity. This is likely to be the case in Maharashtra and Gujarat.

The Reserve Bank of India’s KLEMS database shows that India’s labour income share in financial services is only 35%, and even in business services, it is just 48%. These are two prominent services in Maharashtra. In Gujarat, the petrochemicals sector has flourished, but it is highly capital intensive and labour income constitutes less than 10% of value added in this sector. Not only do the two states’ output data make them look more prosperous at the popular level, it also hides inequality between well-paid and less-paid workers.

Second, people do not spend all their income, but save some of it for future consumption. The higher one’s income level, the higher the likely savings. However, higher saving rates cannot explain lower consumption spending in rural Maharashtra and Gujarat than in rural Rajasthan.

Third, higher per-person state output may overstate the local population’s prosperity if inward migration in the state is high, as in Maharashtra. State output accounts for the value of all production within a state, including goods and services produced by migrants. Migrants send remittances to their families in their home states, mainly in rural areas. So, not all the income generated in a state is spent within its borders. In contrast, household spending is complemented by remittances in states where migrants’ families receive long-distance transfers.

What other insights stand out from the state-wise comparison of household spending?

Although urban residents, on average, have higher consumption spending than their rural counterparts within each state, there are instances where the average rural resident in some states outspends the average urban resident in other states.

For example, Punjab and Kerala are home to India’s most prosperous rural zones, displaying higher per capita real expenditure than urban Odisha, Madhya Pradesh, West Bengal, Uttar Pradesh and Bihar.

The urban parts of Punjab and Kerala, however, are not the most prosperous urban areas in the country. This pattern suggests that rural parts of the two states tend to benefit from remittances, reducing rural-urban inequality.

Among urban areas, urban Karnataka and Haryana are India’s most prosperous. An IT sector boom and related services have led urban prosperity in these two states. Again, like Maharashtra and Gujarat, their consumption spending and per-person output are relatively divergent.

However, low rural-urban inequality in consumption spending does not necessarily mean that state policies are responsible for such an outcome. In Bihar, which shows the lowest average consumption spending among major Indian states, the rural-urban gap in spending is also among the lowest. Rural average spending in real terms is higher in Bihar than in rural Odisha, West Bengal, Uttar Pradesh and Madhya Pradesh. Rural Bihar appears to benefit significantly from inward remittances sent by Biharis working in other states.

In sum, the most widely used measure of state-level prosperity, per capita NSDP, could be a misleading indicator of people’s ability to spend on consumption and improve their living standards. This is why we need a holistic picture of economic prosperity formed by multiple data sources.

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