Retirement saving myths

The standard portfolio model is flawed because it ignores human capital, according to economist Joseph Stiglitz

Cafe Economics | Niranjan Rajadhyaksha

Most of the financial advice we get is hopelessly inadequate and simplistic—if not outright wrong.

Last week, I heard Joseph Stiglitz launch a typically blunt and brilliant attack on some of the sacred cows of the financial advisory business. The economics professor at Columbia University in the US and winner of the 2001 Nobel Prize in economics is popularly known as a trenchant critic of some aspects of globalization, though his academic work spans a wide range of economic issues, including financial ones.

“Long-term financial planning is a very complex task. Individuals cannot judge what they need to do and so they fall prey to wrong advice. This gives rise to fashionable rules of thumb,” said Stiglitz in a presentation at the Second European Colloquia organized by Pioneer Investments in Vienna at the end of November. (Disclosure: I was in Vienna as a guest of Pioneer Investments.)

The most common rule of thumb is that an individual should invest heavily in equities at a young age and then gradually move into bonds as the age of retirement nears. A popular and pseudo-scientific way of defining this rule is as follows: subtract your age from the number 100, and you get your ideal exposure to equities. For example, a 30-year-old should have 70% of his long-term savings in equities (100-30) while a 50-year-old should bring it down to 50%.

Neat, huh? But also wrong, said Stiglitz.

Most financial advice—and the economics that underlies it—is flawed. It assumes that an individual has only two types of capital: relatively safe fixed-income bonds and equities that are more risky but which also give more returns. The question is how long-term savings should be distributed between the two as we age.

“The standard portfolio model ignores other forms of individual capital,” said Stiglitz. One important form of this is human capital, which is usually calculated as the present value of all the future earnings an individual will earn over his working life.

Most of our value as economic animals resides in our ability to earn over our working lives—our human capital. According to some estimates, nearly 80% of an individual’s capital is human capital. This form of capital and its risk profile should ideally be considered while designing a good financial plan for retirement.

Human capital is usually more risky at a young age, points out Stiglitz. You are just starting off on your career and the future is uncertain. As you age and get settled into your chosen profession, the uncertainty about your ability to earn starts declining. Human capital gets less risky as you age.

Seen from this perspective, most financial plans are built on shaky foundations. A 25-year-old setting out down a fresh career path faces huge amounts of risk in his overall portfolio (financial and human), because his future earnings are uncertain. Ideally, his financial portfolio should have low risk to balance out the high risk in his human capital. He should be buying more bonds than he is usually advised to do. But the cookie-cutter financial advice that he gets is to put most of his savings into equities—and increase his overall risk.

The big question is whether human capital resembles a safe bond or risky equity. In a separate presentation, Stephen P. Zeldes, a professor of finance and economics at Columbia University, asked: “Is labour income stock-like or bond-like?” He suggested there are no easy answers here. Without disagreeing with Stiglitz, Zeldes said labour income has both characteristics, depending on the circumstances.

All this makes financial planning a complicated process. Besides, other factors such as which industry one is working in, the nature of one’s family responsibilities and home ownership also need to be thrown into the consideration. In a country such as India, for example, where a large part of the population is self-employed, labour income would tend to be risky.

Perhaps we are wrong in blindly assuming that we should cut our exposure to equities as we age. In fact, a well-settled professional with stable earnings perhaps has more reason to invest in equities than, say, a young entrepreneur in a technology start-up.

These are nuances that are often ignored, even in our grander debates on how pension fund money should be used in India.

One challenge before those involved in designing social security systems is how to balance freedom of choice and good guidance. Choice is important because an individual knows about his retirement needs than outsiders. But, as Stiglitz pointed out, individuals make rational decisions by learning from past experiences—their own and of others. That’s not possible for retirement planning. A person who realizes at 60 that he has not saved enough for his retirement cannot say: “I’ll do better next time.”

There is no second chance.

Your comments are welcome at cafeeconomics@livemint.com

Alfred Marshall in Bhiwani

Bhiwani seems to have a boxing ecosystem just as Bangalore has an innovation ecosystem or Mumbai once had a cricketing ecosystem

Cafe Economics | Niranjan Rajadhyaksha

The gutsy boxers of Bhiwani have perhaps never heard of Alfred Marshall. But I think that something the great economist wrote more than a hundred years ago, on why some activities tend to flourish in certain towns and regions, has echoes in the Bhiwani of today. And what Marshall and other subsequent economists have written about geographical specialization and clusters could help India cobble together a better strategy for the 2012 Olympics in London.

Online encyclopedia Wikipedia quite aptly describes Bhiwani as “the Kashi of boxing”. Three pugilists from the town — Akhil Kumar, Vijender Kumar and Jitendra Kumar — went through to the quarter finals while Vijender Kumar went on to win a bronze medal in the recently concluded Beijing Olympics. There has been a flood of newspaper reports since then on the vibrant boxing culture in Bhiwani.

Marshall was one of the first economists to ask why certain occupations and industries tend to cluster in a particular town: cutlery in the Sheffield and pottery in the Staffordshire of his times, for example. “When an industry has thus chosen a locality for itself, it is likely to stay there for long: So great are the advantages with people following the same skilled trade get from near neighbourhood to one another. The mysteries of the trade become no mysteries; but are as it were in the air, and children learn from many of them unconsciously.”

Boxing is clearly in the air in Bhiwani, in the sense Marshall wrote about. The town seems to have a boxing ecosystem just as Bangalore has an innovation ecosystem or Mumbai once had a cricketing ecosystem. And the success of the three fighters coming out of Bhiwani clubs shows that specialization works in sports as well as it does in business. Furthermore, just as certain towns are good at certain sports, it seems that entire countries too have core competencies in the sporting arena.

This simple fact should help Indian sports administrators and private charities design a sensible strategy for the next Olympics in London. And it should be based on doing what India seems to be good at.

Take a look at how the top teams collected their Olympic medals. One would have thought that sporting superpowers such as the US, China and Russia would have had their medals evenly spread around all types of sports. That is not so.

The US picked up a total of 110 medals in Beijing. Sixty of them came from athletics and swimming (the latter no doubt helped by a man called Michael Phelps). Thirty-five of Russia’s 72 medals came from athletics, weightlifting and wrestling. Great Britain won 33 medals in cycling, sailing, rowing and kayaking; its grand total was 47. Australia won 20 of its 46 medals in swimming while it bagged five more in canoeing and kayaking. Thirteen of Japan’s 25 medals came from judo and wrestling.

China has its medals more evenly spread across various sporting pursuits, perhaps a reflection of its authoritarian and state-driven sporting set up that perhaps mirrors a similar economic programme where the government pushes the development of industries it thinks China should be strong in. But even China has stood out in a few disciplines such as shooting, diving and gymnastics.

Looking at the way various countries have won Olympic medals this year, there is a clear sense that what works in the world of economics seems to work in the world of sports as well. As more countries become participants in the “market” for Olympic medals, each individual country tends to focus on doing what it is best at. Or: Division of labour increases in tandem with the growth of the market. That we have known since the days of Adam Smith.

And it is perhaps the way forward for India as well — both the Indian Olympic Association and the various private foundations that are ready to fund sporting excellence.

The tricky question is how to identify what sports India is really good at. There is a centralized and managerial way of doing this: Identify a few fashionable or influential sports and say that India should have a dominant presence in them. This approach is close to what proponents of national industrial policy say: Let’s identify a few prestigious industries such as semiconductor manufacturing or car making and support them with money and subsidies.

The other approach is a more experimental and market-oriented one: watch where Indians are winning — either in global markets or sporting tournaments—and then ask what can be done to help those who are active in these areas. In other words, let the markets rather than bureaucrats pick the potential winners.

There are already some signs that are evident to even couch potatoes: India’s best medal chances were in shooting, wrestling, boxing and court games such as badminton and tennis. Let’s build on them.

Your comments are welcome at cafeeconomics@livemint.com

Escaping caste traps

An experiment by two economists shows people can lose out even when there is little overt caste discrimination

Cafe Economics | Niranjan Rajadhyaksha

A neat little experiment conducted by two economists in 2004 tells us a lot about a very contemporary debate —the persistence of caste traps. It is useful to revisit their experiment at a time when the reservations debate has flared up once again. This experiment suggests that caste is a deep-rooted problem that can persist despite laws banning discrimination as well as more specific interventions such as selective reservations.

Karla Hoff of the World Bank and Priyanka Pandey of Pennsylvania State University collected a group of 622 boys and girls at a junior high school in a village in Uttar Pradesh. They wanted to find out the effects of caste on performance. These students were in classes VI and VII. Half were from the so-called upper castes and the other half from the so-called lower castes.

The children were asked to solve a maze. Those who successfully completed the game were rewarded with money. So, there was a clear economic incentive to play the game for the benefit of the researchers. At first, the castes of the participating children were kept secret. There was very little difference between the success rates of children across castes during this part of the experiment.

Then the castes of the participating children were publicly announced during a second round of the experiment. The lower-caste children suddenly performed significantly worse during this round. The number of mazes that they successfully solved fell by a quarter.

The results of these trials show that people can continue to be victims of caste and racial stereotypes even when there is no legal discrimination in a society. We are aware of how biases affect the way people from certain castes are perceived. The problem here is different: Stereotypes become self-fulfilling. People tend to unconsciously behave in accordance with the way they are stereotyped. Similar experiments have been conducted in the US. One shows how the performance of black Americans taking the Graduate Record Examination (GRE) slipped when they filled questionnaires asking them to reveal their race.

Such experiments show that people tend to conform to stereotypes—and could lose out in life though there is little overt discrimination.

There are several reasons to be wary of jumping to any grand conclusions from the results of one experiment. First, the Hoff-Pandey trial was conducted in rural Uttar Pradesh, a region that has seen far less social reform, economic development and mobility than many other parts of India. So, it is an unrepresentative region in many ways. And the results cannot be used for national policy.

Second, the current debates on reservations in education are focused on the intermediate castes rather than the lower castes. Members of these castes have never suffered the brutal discrimination that the Dalits faced over the centuries. I doubt the caste factor would be so important in case the two groups of children solving the maze were from the “upper” and “intermediate” castes.

One solution is to create or support a “big push” to break the fetters of caste stereotypes. “Policies attempting to reduce inequalities need to be highly cognizant of the prevailing cultural norms. In the low-caste case, for example, simply giving supply-side incentives or reservations alone may not solve the problem. The tug of the prevailing norms can be stronger than material interests. The flip side of this logic produces a classic “big push” type of argument. If some small group of individuals who are typically discriminated against does manage to break the norms and succeed, the effect can be powerful. They can serve as role models for many others and remove at least the norm-induced barrier,” says Harvard economist Sendhil Mullainathan in a recent paper.

This happened in Maharashtra with the success of B.R. Ambedkar, who showed millions that there could be a life beyond the traditional demeaning jobs that others in his caste were condemned to. One example: Narendra Jadhav, who grew up in the slums of Mumbai, rose to become chief economist of the Reserve Bank of India and is now vice-chancellor of Pune University, writes in his autobiography how as a child his aim in life was to become a petty gangster. That was what his peers became. It was the Ambedkar movement that led Jadhav to the road to success. He, too, is now a role model for the next generation of Dalits.

Finally, hear what the World Bank says in its World Development Report 2006: “Discrimination and stereotyping have been found to lower the self-esteem, effort and performance of individuals in the groups discriminated against. This reduces their potential for individual growth and their ability to contribute to the economy.”

Caste is a tricky issue and there can be no easy answers. But, it is unfortunate that the debates all around us depend more on passion rather than fact. Meanwhile, cynical politicians such as Arjun Singh can play the divide-and- rule game.

Your comments are welcome at cafeeconomics@livemint.com

Prince and pauper

The extent of inequality in India seems to be stable, from Mughal India to our times

Cafe Economics | Niranjan Rajadhyaksha

It is common to hear the claim that inequality has increased because of economic reform and globalization. Most debates on this important issue end up as shouting matches. But is the claim really true?

Data I have seen this week show something eye-catching: The extent of inequality in India seems to have been remarkably stable over the centuries. The Mughal Empire collapsed. The British came and left. Independent India emerged from the pains of partition and now sees itself as an emerging superpower. Through this long cycle, the country seems to have maintained its level of equality/inequality.

First, let’s look at the immediate numbers. Mint reported last week that inequality in India had actually decreased between 1997 and 2005, going by the estimates published in the United Nations Development Programme’s human development reports. Inequality is usually measured with the Gini coefficient. A Gini of one means a country has perfect equality and a Gini of 100 indicates perfect inequality. India’s Gini coefficient has fallen from 37.8 in 1997 to 36.8 in 2005.

India is perhaps more equal today than it was around 10 years ago. That’s something that the critics of reforms have to deal with.

As with all such estimations, this one, too, can be questioned based on the quality of data and the definitions used. But that is not the point of this column. What struck me is that inequality in India has been surprisingly steady over the very long run. The data I will quote below are taken from an interesting new research paper, Measuring Ancient Inequality, by three economists—Branko Milanovic, Jeffrey G. Williamson and Peter H. Lindert. The original data that the three use is from economist Angus Maddison, whose work on world incomes since the dawn of history is incomparable. (A quick note: The main point of the Milanovic, Williamson and Lindert paper is quite different from the focus of this column.)

Let’s take an initial step back into history. The first official measure of inequality in independent India was in 1951, when the National Sample Survey field workers first went knocking on doors. The Gini then was 36, not too far from what it is today, according to the latest data. Inequality has stayed around that level through the ups and downs in the Indian economy over the next six decades and more.

But we could step even further back in time, all the way to the Mughal era. Naturally, data were scarce in those days. So, these are broad estimates. First stop: British India just before independence. The average Gini at that time was 48.9.

At first glance, it may seem that inequality dropped dramatically after the British left India. One possible reason is that the top British officials —from the viceroy to the judges to the district collectors—packed their bags. Maddison says that top British officials and businessmen made up just 0.06% of the total population of India, but they mopped up 5% of the national income. The Indian nobility and business class accounted for another 0.94% of the population and 9% of the national income. Thus, the 1% at the top of the income pyramid got 15% of total income.

However, Milanovic, Williamson and Lindert say that even without the British, the Gini would have been a high 45. Even so, there is a nine-point gap between inequality in 1947 and in 1951. The three economists offer four explanations. One, the 1947 Gini was based on incomes while the 1951 Gini was based on expenditure. So, is expenditure more equally distributed than income? Two, Maddison overestimated 1947 inequality. Three, he underestimated the incomes of India’s poor. Four, inequality did indeed drop after the British left and India became a free republic.

Let’s stick to reason number one for now and assume that there is a nine-point gap between income inequality and expenditure inequality. And then take another leap into history, back to the era of the Mughals. Around 1750, the Mughal nobility and zamindars accounted for 1% of India’s population and 15% of the total income. That’s remarkably similar to what the top 1% of the population—British officials, British businessmen, Indian nobles and Indian businessmen—got in 1947. The Gini in 1750 was 43.7%, very close to the “non-British” Gini at the eve of independence.

This is astonishing. The data shows that the extent of India’s inequality has been remarkably similar over the centuries, be it in Mughal India, British India or independent India. Of course, there must have been ups and downs depending on the economic and political circumstances. But the overall picture has not changed much. Is this our “natural” rate of inequality?

That’s a sobering thought amid the noisy debates.

The entire paper on measuring ancient inequality can be read at www.nber.com.

Your comments are welcome at cafeeconomics@livemint.com

No longer a bottomless pit

Subsidies and rural employment generation schemes are politically attractive ways to help the poor, but they are usually wasteful and short-term fixes

Cafe Economics | Niranjan Rajadhyaksha

India’s farm economy will create no new jobs in the coming years — and that is good news.

The Planning Commission estimates in the 11th Plan that the number of workers in agriculture will stagnate between 2006-07 and 2011-12 — and then drop by around four million in the subsequent five years. This is perhaps the first time since data has been collected that Indian agriculture will no longer be the bottomless pit in which the unemployed and unemployable are hidden.

The actual economy rarely jumps through the hoops that planners hold in front of it and so the eventual pattern of employment may be quite different from these estimates. Yet, what the Planning Commission expects is truly extraordinary. If fewer people in absolute terms will be busy on the farm from now on, not just the economy but India as a country would have changed — becoming less agricultural and perhaps more urban.

Jobless growth is usually not welcome. It is only when new jobs are created that the benefits of economic growth filter down to more people. That is the true meaning of inclusive growth — the ability to provide quality jobs to as many people as possible. In fact, the phrase “inclusive growth” gained wide currency only at the beginning of this decade, when there were widespread fears that the rapid economic growth of the 1990s was not creating enough jobs or bringing down poverty fast enough. Subsidies and rural employment generation schemes are politically attractive ways to help the poor, but they are usually wasteful and short-term fixes. They do not eventually lead to truly inclusive growth.

Gainful employment is the only way out. An earlier instalment of this column had quoted Nobel Prize-winning economist Edmund Phelps as saying this: “High wages enable workers to solve various problems, participate in the economy and live with dignity.”

Agriculture has kept absorbing people. The problem is that new jobs created in agriculture amount to disguised unemployment. In other words, it is possible to produce the same amount of farm output by employing fewer workers. But there were few jobs outside agriculture and millions were trapped in low-productivity work in farms. Indian farms are family-owned, so family members who have no job opportunities outside end up toiling on the same patch of land that already employs too many people.

That is why jobless growth in agriculture should be welcome. The farm income pie will not keep getting cut into ever-smaller pieces; incomes would improve.

But, where are the alternative jobs — both for new entrants into the labour force and the four million or so who will leave their farms?

And this is where the Plan documents point to really interesting possibilities. The traditional answer is that people moving off the farm will eventually be absorbed in labour-intensive manufacturing. That is what happened across Asia, in countries such as Taiwan, South Korea, Thailand and Malaysia. Farm labour moved into the cities and export zones to work in factories that made toys, textiles, computer chips and the like for the export market. There are too many obstacles to the growth of such labour-intensive manufacturing in India, including labour laws that protect those with industrial jobs but harm prospective workers.

The Planning Commission says it expects an extra 11 million manufacturing jobs in the five years to March 2012. But that’s not where the story ends. Almost an equal number of new jobs will be created in the construction industry. Trade, hotels and restaurants will absorb an extra 17 million workers. And another nine million will find jobs in transport, storage and communication.

What this means is that we will be seeing radical change in the Indian workforce. Fewer people will be toiling away on farms in rural India. New workers will find employment in factories, but far more will be busy at construction sites, restaurants, retail outlets and warehouses.

Such work will not necessarily allow them to live better. A lot will depend on the details. A job in retail? Does that not mean standing at the check-out counter of a large department store or toiling away in a corner shop? Construction work? With an engineering company that invests in worker safety or some site that has never seen a hard hat? And what of proper labour contracts, decent wages and social security?

The Planning Commission has raised a very valid issue in the 11th Plan: what it calls the informalization of employment. Too many Indians will continue to have jobs in tiny and unorganized workplaces. The growth of the formal sector will hopefully lead to better working conditions and wages. That is something those opposed to modern retailing and the reform of land laws should understand.

Your comments are welcome at cafeeconomics@livemint.com

Dreaming of Swatantra

Modern India’s only stab at a successful liberal party started in August 1959; the Swatantra Party would have entered its 50th year this month, if it had survived as a national political force

Cafe Economics | Niranjan Rajadhyaksha

Nobel laureate Amartya Sen — who is not a free-market liberal — has spoken on how contemporary India needs a right-wing political party that is both secular and committed to an open economy. This is a good time to go back to the issue, for two reasons. First, we have seen how economic reforms were blocked by the Left to begin with and have now been hijacked by the crony capitalism of the Samajwadi Party. Second, modern India’s only stab at a successful liberal party started in August 1959; the Swatantra Party would have entered its 50th year this month, if it had survived as a national political force.

Fifteen years of high growth, thanks to economic reforms, should have created a strong political base for liberal party. It hasn’t. I am often surprised at how even people who have benefited from economic reforms still believe that the government should control prices to beat inflation or that companies are making too much profit at the cost of society. Is it any wonder that no party is ready to face the electorate with a free market agenda?

The interesting question is why this happens. The answer involves more than political failure. The nature of Indian society and capitalism are also part of the answer.

An interesting new research paper by Philippe Aghion of Harvard University, Yann Algan of the Paris School of Economics, Pierre Cahuc of the Ecole Polytechnique and Andrei Schleifer of Harvard University offers one set of clues. They have mapped the relationship between demands for regulation in a country and the level of distrust between its citizens.

What these four economists show from their study of rich nations is that people ask for more government regulation when they do not trust their fellow citizens. They have used a concept that has attracted a lot of attention over the past decade and more — social capital. Any economy needs physical capital (tools), financial capital (money) and human capital (skills) to grow. It also needs social capital (trust). Economist Kenneth Arrow once said that virtually “every commercial transaction has within itself an element of trust, certainly any transaction conducted over a period of time. It can be plausibly argued that much of economic backwardness in the world can be explained by the lack of mutual confidence.”

Aghion and his three fellow authors show in their July paper, Regulation and Distrust, that countries with low levels of trust in other persons, companies and political institutions are more likely to have more regulations on economic activity. But this regulation leads to low growth and corruption, as we know from our own experience of the licence permit raj. “What is perhaps most interesting about this finding…is that distrust generates demand for regulation even when people realize that the government is corrupt and ineffective; they prefer state control to unbridled production by uncivil firms,” say the economists.

The way companies earn profits does affect the popularity of capitalism. In a paper published in 2006, Rafael Di Tella of Harvard Business School and Robert MacCulloch of Imperial College ask: Why Doesn’t Capitalism Flow to Poor Countries? They say the most important factor is corruption, which cuts into the “moral legitimacy of capitalism”. Di Tella and MacCulloch add: “Existence of corrupt entrepreneurs hurts good entrepreneurs by reducing the general appeal of capitalism.”

These two pieces of research show that the popularity of a free market political party will depend on both the level of trust in a country and whether profits come from competitive markets or oligopolies protected by the state.

Economic historian Douglass C. North and his colleagues have given us what they call a conceptual framework to interpret human history. They say that societies emerge as “limited access orders”. Here, the political system is used to limit economic participation and impose social order. The lack of economic competition leads to excess profits that are used to limit violence and maintain political stability.

North says that some societies later evolve into “open access” orders. Here, there are few restrictions on economic and political participation, which is another way of saying that these societies have open economies and open political systems. Order is maintained through the competitive process.

There is a famous story about Margaret Thatcher. Soon after she became head of the Conservative Party in the UK, she is said to have reached into her briefcase and pulled out a copy of F.A. Hayek’s Constitution of Liberty, a book that explains with great clarity why liberal systems lead to freedom and prosperity. Interrupting the speaker, she is said to have banged the book down on the table and said: “This is what we believe.”

Is there any Indian politician who has similar convictions — and the guts to make them public?

Your comments are welcome at cafeeconomics@livemint.com

Our urge to splurge

New spending data from the government captures the vast changes in middle-class family budgets

Cafe Economics | Niranjan Rajadhyaksha

I was a bemused onlooker to a recent discussion between my wife and her partner in shopping crime. They were discussing family budgets. The main point was that while family incomes have increased almost beyond imagination over the last 10 years, spending has grown apace.

I am quite sure that’s also the experience of most Indian families which have benefited from the recent burst of economic growth. The bank balance doesn’t quite meet the targets set when we get our new salary deals and our annual bonuses.

What my wife and her friend were talking about is backed by numbers—including a new set of data on savings and consumption trends in India, released a couple of weeks ago by the government statistics office. These numbers show that there have been vast changes in how India accumulates and spends money. Family budgets today are radically different from what they were at the end of the last century. And they will change even further in the years ahead.

First, consider savings behaviour. India as a whole now stashes away a far bigger proportion of its national income than ever before. But that’s because of a jump in corporate and government savings, rather than in household savings.

The gross financial savings of Indian families have risen from 13.9% of the gross domestic product in 2003-04 to an estimated 18.4% in 2006-07. But that’s what we collectively squirrel away before servicing our debt. Once that factor is taken into account—the money we have borrowed from banks to buy houses and consumer goods and (alas) overpriced initial public offerings as well—it’s clear that the net savings rate of Indian families has barely budged over the past four years.

But this doesn’t mean that the story on the spending side of the family financial ledger has been just one of uniformly climbing expenses: buying the same stuff we always did, only lots and lots more of it. In fact, how we spend our money has changed drastically over the past few years as incomes have increased.

We splurge a larger share of our incomes on mobile phones, eating out, transport and recreation—but surprisingly, not as much as we believe on education and health. We also eat differently, as even a cursory glance into our fridges and kitchens shows. And as far as indulgences go, tobacco is losing importance and what the bean counters call intoxicants have become more important in our lives.

There are hard numbers to back our individual experiences. New spending data captures the vast changes within middle-class family budgets in recent times.

The quick estimates of national income, consumption expenditure, saving and capital formation for 2006-07 were released by the Central Statistical Organization on 31 January. They show that total private final consumption expenditure—largely made up of household spending—increased at an annualized rate of 8.12% in the five years between 2002 and 2007. That’s at current prices. At constant prices, the rate at which private consumption spending has increased at 5.03%. The difference between the two rates of growth—3.09%—is a proxy for consumer price inflation.

But there have been deep changes within this overall trend. In 1999-2000, spending on food, beverages and tobacco accounted for 51.5% of the total spending by Indian families at current prices. That dropped to 42.7% in 2006-07. (The drop after taking inflation into account is less sharp). This means that we are spending a relatively smaller part of our incomes on food than before, which is quite natural in a country that is emerging from poverty.

There are signs of growing prosperity within this category as well. Consumer eating preferences have shifted from the traditional cereals, bread and oilseeds towards stuff such as fruit, milk, meat and even intoxicants. Spending on tea, coffee and cocoa has actually dropped in nominal terms—not quite in tune with our daily experience of umpteen cups of caffeine and crowded city cafés.

On the other hand, our expenditure on communication has exploded, increasing from 1.2% of spending in 1999-2000 to 2.7% in 2006-07 (at current prices), undoubtedly helped by the mobile telephony revolution and deflation in call charges. Indians now spend more on communications than they do on tobacco or hotels and restaurants. And even on education. It was not so at the beginning of this decade.

India is still a country with too much poverty. But there are signs of change. We see this in the broader data on average incomes, which have crossed $1,000 a year. But the consumer spending statistics also show how India is changing—from the daily struggle of getting food to the growing aspiration to eat better, send children to school, own a mobile phone and perhaps have a drink or two.

Your comments are welcome at cafeeconomics@livemint.com