I traveled over the weekend to speak about the Indian economy in a pedagogy workshop on macroeconomics at Azim Premji University in what is euphemistically called Bengaluru. Even in the decade-long period when I formally studied economics, macroeconomic theory was not really my thing. But I do remember some of the ideas from my courses. One of them is the Life-Cycle Hypothesis, developed by Franco Modigliani and Richard Brumberg. It suggests that people tend to rationally plan their consumption and savings, aiming to smoothen it out over their lifetimes rather than tying it strictly to their current income. You borrow when you are young and earn little, save when you are at the peak of your career and use the savings when you are not earning. Mogdiglani was awarded the Nobel Prize in the subject for his work.
Rationality, of course, is a pretty abused concept in macroeconomics. Irrationality, while commonly found, is of course, more difficult, and less elegant to theorise. At the risk of doing the clichéd cab driver thing, let me present a new insight from my travel. I heard a new; of course, irrational, theory of consumption from the person behind me in the queue while boarding my plane at the Delhi airport. Let us call it the salary cycle hypothesis theory. "As soon as salary comes, I do not find home food tasty anymore and feel like eating out. Ten days later (once the salary runs out), the same home food tastes so nice," he explained to his co-traveler in a half-animated half-profound manner.
The economic idea is pretty simple: his consumption demand function (whether to eat expensive food outside or cheap food at home) is closely tied to short-term liquidity which is what the arrival of salary signifies. This puts Modigliani and Brumberg upside down: planning consumption and income over an extremely short-term horizon.
{{/usCountry}}The economic idea is pretty simple: his consumption demand function (whether to eat expensive food outside or cheap food at home) is closely tied to short-term liquidity which is what the arrival of salary signifies. This puts Modigliani and Brumberg upside down: planning consumption and income over an extremely short-term horizon.
{{/usCountry}}Now, you can accuse me of over-dramatising my travel experience and say that such behaviour – spending beyond means especially for short-term gratification – is pretty common among many people, especially the young. Guilty as charged, but what really is driving this behaviour?
This column usually confines itself to what can often be described as turgid, 20th-century political economy jargon. But if the next generation is going to be shifting from life-cycle hypothesis to salary-cycle hypothesis, it will become political economy sooner rather than later. How do we explain this?
What economists call demonstration effects are definitely at play here. X has an iPhone or went to eat dinner there; I want that too, and will post it on Instagram. Thanks to the internet, social media and rising financial inclusion, which has also facilitated an across the income spectrum debt binge, there has been a great trickle down of demonstration effect across the income hierarchy. Even in a Tier-3 town, you can very well buy online what is only being sold (physically) in metro towns . The shopping equivalent of shoe-leather cost of banking has disappeared for all practical purposes.
But this does not really explain it all. One would like to believe that there is still something called prudence. Nobody really likes the idea of going belly up, financially speaking. This is where the real leap of faith exists in my view. In many industries in India (specifically service sectors)—and this group is only growing—multiple cohorts of workers already exist. The oldest cohort has really enjoyed, to borrow an equity market term, multibagger upward mobility over the past two-three decades.
The best cohort consists of those who started working just after economic reforms and peaked by the global financial crisis of 2008, thereby making the most of India’s growth boom and private sector’s disproportionate gains from it. One of the lines from my final year BA lecture on the Indian economy (this was in 2003) that has stayed with me forever is my professor telling us that what economic reforms did to India’s middle class was sons and daughters earning more in starting salaries than what their government job parents were earning at their retirement.
Not only did the multibagger generation make income gains, but they also exploited significant capital gains across markets, especially in real estate and equities. With each generation, the upward mobility curve for income is becoming flatter, and capital markets, especially real estate, are now facing headwinds rather than tailwinds.
To give you an example, many sought-after private sector jobs still offer opening salaries which are what they were more than a decade ago or even earlier. Enter AI, and the situation will become worse. A friend I met in Bengaluru who works in a senior position with a VC firm, very cheekily told me that between her, Claude (the AI model) and her boss, all the work could be done. Even a few years ago, landing an entry or mid-level job in her company would be a great early, even mid-career move.
This is not to cast aspersions on the quality of India’s white-collar workforce, but one of the things about good economic times is all boats, shiny or dull, and leaky or strong, get lifted by the growth tide. When you see this happening, you tend to—and definitely like to—believe that the lifting tide is a fact of life and not a cycle. There is a very thin line between belief, optimism and obduracy and what follows -- entitlement.
A lot of India’s young workforce, especially from its economically privileged cohorts, has seen such upward mobility happening to their parents and earlier generations and perhaps takes similar things for itself for granted. To be sure, a lot of them might already be facing anxieties, but there is good reason to believe that they are significantly smaller on an ex-ante basis than their ex-post variant. You do not think AI or a mid-career stall will affect you until it has.
Before you accuse me of middle-age mansplaining, let me cut to the chase. Even if the younger cohort of workers were to realise these headwinds, what can they really do about it?
Financial planning such as the one taught in macroeconomic models assuming rationality does not really work in real life. If everybody were to start spending according to their means, or lack thereof, the economy would experience what Keynes termed the paradox of thrift shock, when everyone trying to save would actually drag down consumption and growth and do more harm than good. From a strictly Keynesian perspective, ‘delulu is the only solulu’ inspired consumption behaviour of the younger workers isn’t really a bad thing. Keynes, being the 19th-century-born economist that he was, called it animal spirits and not delulu or solulu.
But to do just that would be misreading Keynes. Keynes’s greatness as an economist comes not just from his academic brilliance but also from the fact that his economics, when married with politics, created one of the most egalitarian phases in the history of capitalism in advanced countries, especially the US. The world, as we know it today, is changing. The utopia of free markets, a rules-based order, and even globalisation is being tested daily. The world of economists and the politicians can definitely do without the 'delulu (hoping for a status quo ante) is the only solulu. They, not Gen Z, are more guilty on this count.
(Roshan Kishore, HT’s Data and Political Economy Editor, writes a weekly column on the state of the country’s economy and its political fall out, and vice-versa)