Monthly Archives: March 2013

On Powerful Macroeconomic Concepts: Consumption Smoothing

The idea of consumption smoothing is a very powerful one and seem to underlie a variety of economic as well as social phenomenon. In what follows I discuss a few examples to illustrate this. Consumption smoothing implies that the people prefer a smoother consumption path over a relatively choppy or fluctuating one. The ability to smooth consumption differs across countries and within countries across income classes. For example it has been documented that private consumption expenditure in developed countries is less variable than the real GDP at the business cycle frequencies, while in the developing countries it is more variable than the real GDP. This difference can be explained by differing access to credit markets as well support from governments in terms of welfare spending. You can read more about this here and here.

A couple of research papers on India also highlight how consumption smoothing can help explain patterns of migration and marriage as well as the probability of survival of a girl child in rural India. For example, Rosenweig and Stark (1989) find evidence among rural households in India that marriages are arranged between families that come from areas with different income risks. This allows for inter-household transfers of good and services and helps households to tide through rainfall shocks. Such arrangements are important in the absence of formal agricultural insurance products and difficulties in credit provision. Rainfall shocks are not uniformly distributed over the region and hence such flow of goods and services associated with such marital arrangements helps families smooth consumption in difficult time periods.

In another study on India, Elaina Rose shows that one can explain excess female mortality in rural India with the help of consumption smoothing. Using data from almost 4000 rural households, Rose finds that the ratio of probability that a girl survives until school age  to the probability that a boy survives to this age is related to rainfall shocks in childhood. This ratio shows improvement for a cohort that experiences a positive rainfall shock in the first two years of life.   This means that when there is an increase in income or purchasing power of a household because of good rainfall, the probability of a girl child surviving improves as households can afford to allocate more resources to the girl child. The opposite happens when there is a negative rainfall shock. The general  importance of rainfall shocks in fluctuations in Indian GDP is discussed here.

However dismal these findings, they have important implications for government policy. As Rose argues, becuase excess female mortality in rural India is associated with inability to smooth consumption  through other means, promoting institutions that provide alternative mechanisms to smooth consumption might do far good in improving survival of the girl child than any other policy. In case you doubted the importance of insurance and other financial products that provide a hedge against income fluctuations, you will find som solid argument here!



Filed under current economic issues, indian economy, macroeconomics, social perspectives