The Consumption Conundrum

Neelkanth Mishra | March 28, 2024, 11:45pm

This was published in the Economic Times on 29 March 2024 (link).

‘If the economy is growing so fast, why is our volume growth so weak?’ is a question asked by management teams of several large consumer companies. These concerns have intensified after the recent strong GDP release, even as they continue to observe weak trends.

There are four reasons for this divergence:

Too invested in investment: India’s post-pandemic economic recovery has been investment-led. When households buy new houses, and expand or repair existing ones, as they seem to be doing, they can’t consume as much. In an economy growing at 7% annually, if the investment share of GDP rises from 29% to 35% over five years, investment will grow at 10% a year, and consumption, whose share would fall commensurately, will grow at 4.8%. This explains why investments are almost back to the pre-pandemic path (that is, where they would have been if the pandemic had not occurred), while private consumption is well below it.

Labour pains: Labour share of national income appears to be falling. An accurate split of capital and labour share is difficult in India. But several proxies point to this trend: weak real wage growth, steady fall in core inflation, especially in services where labour is a large component of costs, like household and personal services, and rising profits of large, listed firms as a share of GDP.

Reason? There are around 15 mn more surplus workers in the economy than before the pandemic. While GDP growth has been surprising positively, its level is more than a year behind the pre-pandemic path, implying more than a year’s extra supply of workers. During the pandemic-driven lockdowns, supply of goods and raw materials kept pace with demand (both slowed down). But one could not shut off labour supply. 12 million workers joined the workforce annually in the last four years.

Given that capital ownership in most economies is generally concentrated in the top 10-20% of households, growth in the consumption basket of the rich is likely to be faster than average, and that of the lower 70-80% of households would be slower.

Small is beautiful: Nearly 60% of the workforce consists of people running their businesses and helpers they employ. Wages account for only 40% of total household income. As much as 35% of household income is the operating surplus generated by own-account enterprises (OAEs) like small retail stores, restaurants, transport providers (bus or auto) and tailoring shops.

Their balance sheets, which were badly hurt during the pandemic as they ate into their capital during lockdowns, are only now starting to heal, as they are now returning to full-scale business. This is also contributing to weakness in volume growth of items in consumption baskets of low-income households.
More importantly, as they regain some of the market share lost to larger firms, post-pandemic, the latter’s reported volume growth would lag market growth. Small firms struggled to operate during intermittent lockdowns. Also, in the global supply shortages during 2021 and 2022, they struggled to get access to raw and packing materials.

For example, if local eateries start offering cheaper pizzas of good quality, larger QSR chains would have to work harder to generate profits.

Global links: Global commodity prices are settling at a meaningfully higher level than in 2019, reflecting the enormous expansion in the global monetary base and rise of sovereign debt in developed countries. This explains some of the lower volume growth so far. But this should be less of a factor going forward, as global goods inflation has eased.

So, to summarise with ballpark numbers, if annual real GDP growth is 7%, given the rising share of investment, consumption is likely to grow at, say, 4.5%. Within that, given the falling labour share of income and weak balance sheets of OAEs, baskets representing the bottom 80% of households may see smaller-than-average growth, say, 3.5%. Further, as larger firms give back some of the market share gains of the last few years, their volumes may grow at 2-2.5%.

These trends may persist for a few years. A reviving real estate market suggests consumption growth may continue to lag GDP growth. Slack in the labour market may persist till GDP catches up to the pre-pandemic path, reversing some of the drop in consumption inequality seen in the last decade.

However, if new policy interventions like providing access to digital payments, affordable loans and access to markets via ONDC allow smaller firms to compete with larger OAEs could repair their balance sheets faster by regaining the share lost in the last few years.

Structural factors could also be at play. An incessant annual supply of workers reminds one of the (Arthur) Lewis growth model, which talks of a sustained multi-decade rise in inequality as workers transition from agriculture to industry. Another Nobel laureate, Simon Kuznets, noted the increase in inequality when economies first started to generate meaningful surpluses (Kuznets curve).

However, given the lack of data, and India’s somewhat idiosyncratic growth model, it may be premature to jump to such conclusions.