Chapter 14 India’s National Income and Standard of Living – Indian Economy


India’s National Income and Standard of Living


National income (NI) is the amount of goods and services produced in a country over a year, measured in terms of money. It is the sum total of wages, rents, interests and profits received annually by the citizens of a country. It can also mean the rewards paid to the four factors of production—land, labour, capital and organization—over a year for their cooperation in producing goods and services consumed by the people of the country. NI is a flow (of income) in as much as it is derived by the factors of production working together on the national wealth (assets) such as natural and physical resources, plants, equipment and technology. National wealth is a fund at any given time. NI is also known as national dividend because it is the total income of the nation, representing the divided incomes of the four factors of production—land getting its rent, labour its wages, capital its interest and organization its profit.

Concepts in National-income Analysis

There are various terms used in the study of NI such as gross national product (GNP), net national product (NNP), NI at factor cost, personal income and personal disposable income. For a clearer understanding of NI estimates, it is important to be able to distinguish between these concepts. Though all these concepts are interrelated and are directly related to the NI of a country, they have certain individual characteristics which make them distinct from one another.

Gross National Product

The GNP is the basic accounting measure covering the supply of goods and services. It is defined as the total market value of the final goods and services produced and exchanged through money in a year. When we talk of final goods, we mean those goods that can be directly used by consumers; such goods are services that are not used again in the production of other goods. Bread, for example, is a final good whereas flour is an intermediate good. Intermediate goods must be excluded from GNP. Moreover, while estimating the GNP of a country, we must take into account the money value of currently produced goods and services. This is because the GNP is a measure of the country’s production during a particular period of time. Thus, if certain goods and services are produced in 2014 but are not sold till 2015, they would still be part of the GNP of 2015. Therefore, GNP is the sum total of all goods and services produced, whether by the government or individuals or by corporations in a particular year and measured in money. No additions or deductions should be made in the total of goods and services. Therefore, GNP = Total government production + Total individual production.

Net National Product

GNP refers to all the goods and services produced in a year without any exclusion. However, in producing goods and services, there is some depreciation or wear and tear of fixed assets such as machines. Suppose some machines are to be used to produce cars. In a particular year, while production is carried out, some machines go out of order because of constant working. They have to be repaired or replaced. Therefore, while calculating the income contributed by car producers, the amount of money to be spent on repair or replacement has to be deducted. It is obvious, then, that when we calculate the NNP, we take into account only the net production of goods and services of the year. At the same time, if as a result of foreign trade, we earn an income by exporting more than we import, we have to add that to our income. If we import more, the loss has to be deducted. Thus,

NNP = GNP – Depreciation or replacement + Net balance from international trade

NNP is a more relevant concept than the GNP because it makes allowances for the depreciation of machinery, equipment, buildings and the like. It is also highly useful because it gives us an idea of how much income has been exactly produced in a particular year. NNP is also sometimes referred to as national income at market prices.

NI at Factor Cost

This is the actual NI we are concerned with. The NI or NI at factor cost is the total of all income payments received by the factors of production—land, labour, capital and organization. It can be derived as follows:

NI = NNP – (Indirect taxes + Subsidies)

This is so because the entire NNP does not reach the people as rewards for the factors of production. The producers have to pay indirect taxes such as excise duty to the government. Thus, this part of total income will not be available for distribution to the factors of production. These taxes are deducted from the NNP. Sometimes, the government also gives subsidies on the production of certain goods such as milk. In other words, the production costs of these goods and services are higher, but on account of governmental subsidies they are sold cheaper than the actual costs incurred in their production. Thus, the factors of production are paid higher than they would otherwise be paid had there been no subsidies. Thus, though these goods and services are sold at lower prices, the factors producing them get higher rewards on account of subsidies paid by the government.

Under these circumstances, if we wish to find out the incomes of the various factors, we will have to add the amount of governmental subsidies to the market value of the NNP.

Personal Income

In national-income analysis, the term personal income is used to denote the sum total of money payments received by the individuals in a country. Personal income is not equal to NNP. NNP does not include transfer payments, such as unemployment allowances or old age pensions, for which no services have been rendered. If we take the case of a son sending money to his old mother, it is a case of transfer payment because a part of the payment received by the son is transferred to the mother. Such income, though not earned, can be spent by an individual and is, thus, considered to be a part of the NI. Again, the NNP includes the undistributed profits of business units because they represent a part of the current production, but they are not available for use by individuals. From this discussion, it is evident that:

Personal income = NI – Corporate income taxes social security contributions – Transfer payments – Undistributed profits

Personal Disposable Income

The term personal disposable income refers to the actual incomes which the individuals can use for themselves. Direct taxes such as income tax have to be paid out of the individual’s personal income. Indirect taxes such as excise duty are included in the price of goods and services purchased by them. Therefore,

Disposal income = Personal income – Direct taxes

However, since the income of the individual is spent partly on consumption and partly on savings, it can be expressed as follows:

Disposal income = Consumption expenditure + Savings

Per Capita Income

The NI divided by the population of the country is called the per capita income or the average income per head. The per capita income is only a rough index of the standard of living in the country because it shows the average amount of income available to its citizen. It is, however, a very inadequate index. In most developing countries, the NI is distributed very unevenly among the people. The greater part of it goes to the richer classes. So, the majority of the people have incomes considerably less than what is shown by the figure for the per capita income. But, though the per capita income is a very inadequate index, it is better than the total figure of NI because it takes into account not only growth in income but also growth in population. Thus, to measure the economic growth of a country over a period of time, the calculation of the per capita income is absolutely necessary. Table 14.1 will help you clearly understand each of these related concepts.

India’s per capita income for the year 2010, for which data is available now, was $1330 according to a World Bank estimate (Devika Banerji, New Delhi). India may lose World Bank soft loans, middle-income status and makes it ineligible for IDA funding.* An earlier estimate by Tata’s Statistical Outline of India, placed it at Rs 37,490 at current prices (2008–09) and at Rs 25,494 at constant price (1999–2000).

Further NI is the aggregate of all the incomes produced in the public sector and private sector in the economy and reflects different components as illustrated in Table 14.2.

Table 1.2 Relationship of National Income and Other Aggregates (At Current Prices)

Measurement of NI

From the three definitions of NI given earlier, it will be seen that the concept of NI can be interpreted in three ways: (i) as the total of the value of production of goods and services; (ii) as total incomes received by the owners of the factors of production; and (iii) as total expenditures of consumers who spend their incomes on purchasing goods and services. This is so because every producer is a consumer and every consumer is a producer; besides, one man’s income is another man’s expenditure, and one man’s expenditure is yet another man’s income. This way, economic activity goes on, covering in its way all the members of the community. Corresponding to these ways of looking at NI, there are three methods of measuring it: (i) the product method, (ii) the income-received method and (iii) the consumption-savings method. We discuss each of these methods in detail in this section.

The Product Method

It is also known as commodity service or output or inventory method. In this method, the net values of all commodities and services produced in the country during a given year are added up. This is the ‘final–production total’ as we take into account only ‘finished’ goods. Calculation with this method is simple as production and trade statistics are available in almost all countries. This method gives us the money value of the NNP.

While using this method, certain precautions should be taken: (a) only ‘final goods’ must be taken into account; (b) additions to the capital assets, such as machinery, used during the period must be included, (c) the net payment from international trade (positive or negative) must be added, and (d) depreciation or replacement costs must be excluded.

Table 14.3 provides the advance estimates of GDP at factor cost by economic activity calculated at current prices for three consecutive years.

Table 14.3 Advance Estimates of GDP at Factor Cost by Economic Activity (At Current Prices)

The Income-received Method

It takes into account the net incomes received by individuals and business enterprises in the country during a year. It is a factor-payments total. In order to get the total incomes, statistics are collected from government reports, tax returns and company reports. The earnings of the higher-income group can be obtained from income tax officials, and those of the lower-income groups can be drawn from census reports and special studies.

While calculating the NI under the income-received method, care should be taken to include only the net incomes of individuals and enterprises so as to avoid double counting. Transfer payments such as pensions, money received by non-working parents from their earning children and beggar’s collection should not be counted as incomes, as they are earned, but transferred from some other incomes. If a producer has contributed his own factors of production such as capital and labour, and if they are components of the cost of commodity, it should be assumed that he would be paid at market prices and adjustments made accordingly. Free services must not be counted. But undistributed profits of companies must be included in the calculation.

Table 14.4 shows how NI is calculated by income method.

The Consumption-Savings Method

Also known as the expenditure method, this consumption-savings method is based on the fact that the total income of the community is spent on consumption and savings. We can calculate the total income by finding out and adding up the total consumption, expenditure and the total amount of savings during a year. As savings, generally, equal investments, this method may also be called the consumption-investment method.

Table 14.5 shows how NI is calculated by the expenditure method.

Table 14.5 National Income Calculation by Expenditure Method

A Comparison of the Three Methods

The consumption-savings method is not generally used because the necessary facts and figures cannot be easily obtained. Normally, the product and income methods are used in the calculation of NI because the data needed for these are readily available. Figures for consumption and savings can be easily derived from the production and income statistics. If consumption and savings or investment figures are available independently, they can be used for checking the correctness of the total obtained.

Thus, for the actual calculations, the NI can be measured either by adding up the value of goods and services produced, or by adding up the money incomes received by the factors of production. Both the methods, even if used independently, will give the same result if adequate precautions are taken. Actually, those who calculate NI usually combine the two methods to get an accurate figure.

The Sectoral Composition of NI

The NI of a country is the sum total of the products (or earnings) of the different sectors involved in an economy. The various components of NI are agricultural income, industrial profits, wages of labour, incomes earned by professionals for their services and earnings from foreign trade. The statistics relating to the NI comprise estimates of the value of all the component parts. Though the earnings of the different sectors are related to one another, each of these sectors makes a different contribution to the income of different countries. Thus, the contribution to NI by different types of occupations or sectors such as agriculture, industry, transport and communications, banking and insurance, is known as sectoral contribution. Normally, as a country progresses economically, the contribution of the industrial sector to the NI increases whereas the share of agriculture in the country’s total income decreases. It is generally believed that if an economy achieves balanced development, the contribution of agriculture to the NI would diminish by at least 1 per cent every year while the contribution of the industry should increase at least by the same amount. The more industrialized a country is, the more advanced it would become economically.

Further, developed countries have experienced a situation wherein the services sector grows more rapidly than even the industrial segment of the economy.

In India, the division of the various sectors of the economy is as follows:

  1. Agriculture including animal husbandry, forestry, fishery and ancillary activities;
  2. Manufacturing industries comprising mining, factory establishments and small-scale enterprises;
  3. Trade and transports, including communications such as post, telegraph and telephone, railways, organized banking and insurance and other commerce and transport; and
  4. Other services such as the professions and liberal arts, government services, domestic services and house property.

According to the Indian National Income Committee’s report published in 1954, agriculture accounted for 50 per cent of our total NI. Manufacturing industries contributed only 17 per cent, whereas trade and transports accounted for 18 per cent of the total. The remaining 15 per cent came from other services. The sectoral composition reveals the one-sided nature of our economy. Compare this to the statistics of the United Kingdom where industries contributed as much as 54 per cent of the NI as early as 1949.

Table 14.6 shows the percentage contributions of the different sectors of the economy to the NI of the country.

Table 14.6 Annual Growth Rates of Real Gross Domestic Product at Factor Cost by the Industry of Origin

Table 14.7 provides India’s gross domestic product at factor cost by industry of origin for the period between 1950–51 and 2006–07 at 1999–2000 prices.

Table 14.7 India’s Gross Domestic Product at Factor Cost of Origin

Estimates of the NI of India

A number of estimates have been made from time to time to ascertain the NI of India. The  earliest of these was made by Dadabhai Naoroji for the year 1867–68. During the post-independence period, there were the following five series in India’s NI estimates: (i) conventional series that provided statistics at current prices (1948–49) for the period 1948–49 to 1964–65. This series split the economy into 13 sectors. Income from six sectors such as agriculture, animal husbandry, forestry, fishery, and factory establishments is calculated by the census of production or output method while the income from the remaining seven sectors that included small enterprises, organized banking and insurance, commercial units and transport, professions and liberal arts, house property and the rest is calculated by the census of income method. The various estimates of per capita income in British India before Independence are shown in Table 14.8.

Table 14.8 Past Estimates of National Income of India

The estimates shown in Table 14.8, scattered over a fairly long period, have different geographical coverage. The concepts accepted for estimation and procedures adopted for calculation differed widely. Thus, as the available data are imperfect, the authenticity of these estimates cannot be verified at this distant period of time to stand scientific scrutiny and verification.

Post-independence Background

V. K. R. V. Rao (1931–32) attempted to calculate India’s NI prior to the country’s independence, i.e., for the periods before 1946, and link it up with the income statistics for periods after 1947. He and his associates confronted innumerable difficulties in finding reliable data during the British colonial era and their earlier attempts proved unsatisfactory. Only for the period after India became independent in 1947 was it possible to find fairly reliable official statistics. Soon after independence, in the year 1949, to be exact, the Government of India constituted the National Income Committee (NIC) headed by P. C. Mahalanobis, with a view to compiling statistics and estimate NI. Other members of the Committee included D. R. Gadgil and V. K. R. V. Rao. The NIC was to be assisted by the national income unit (NIU) which came under the jurisdiction of the Ministry of Finance with a mission to prepare annual NI estimates. The Committee’s final report was submitted in February 1954. The Committee, in its attempt to calculate India’s NI, combined the product method and the income method as to overcome the deficiency of necessary statistics. The NIC used the product method for calculating the net value added by agriculture, forestry, animal husbandry, hunting, fishing, mining and industry. The income method was used for adding up the net income arising from trade, transport, public administration, professional and liberal arts and domestic services. Since the original estimate of 1954 of the Committee, the annual estimates of NI are being compiled and issued by the Central Statistical Organization (CSO) of the Government of India.

Indian NI estimates have been based upon the following four sets of statistical services

  1. Estimates of NI published in 1956 with 1948–49 as the base year;
  2. Estimates of national product published in 1957 as a revision of the conventional series with 1960–61 as the base year. This revised edition gradually began to include such NI components as personal consumption expenditure, savings, capital formation, factor incomes, consolidated accounts and public sector accounts. In 1975, the National Institute of Statistics (NIS) was renamed as national accounts statistics (NAS) and included estimated values for the period between 1950–51 and 1972–73;
  3. The second revised edition was published in 1978 with 1970–71 as the base year. In 1980, estimated values commencing from 1950–51 were published; and
  4. A new series published in 1988 had 1980–81 as the base year. During the following year, estimated values between 1950–51 and 1979–80 were published under this series.

Special Features of the 1980–81 Series

The 1980–81 series adopts a twin approach to compile NI estimates.

  • Estimates of domestic production by industrial origin: The primary method used to compile estimates of domestic production by industrial origin was to calculate gross value added by calculating the difference that arises between input and output values. Such a production-based approach takes into account sectors including agriculture, forestry, fishing, manufacturing ( excluding unregistered manufacturing) and construction.
  • Estimates of factor payments using the income approach: For other sectors, such as electrical power, transportation, commerce and administration, the income approach was adopted in which factor payments are estimated. Organized sectors mean registered private sectors and the public sector. Estimates of income from these sectors were based on annual reports of corporations and budget documents. ‘Applied to unorganized sectors, the income approach means multiplying value added per worker by labour force (number of workers). In addition the commodity flow method has been adopted to estimate private final consumption expenditure and capital formation.’5

The revised series contains data on and methods of estimating forestry including firewood, unregistered and decentralized textiles sector, kutcha construction work and such diverse areas of domestic industrial production. Very important and significant revisions were also made pertaining to consumption, savings and capital formation.

A new revised NI series with 1999–00 as the base year was introduced by the CSO recently. ‘Besides shifting the base year, the New Series incorporates improvements in terms of coverage and to the extent possible the recommendation of the United Nation’s System of National Accounts 1993 have been incorporated.’6

RBI’s Role in NI Accounting

In addition to the CSO, the Reserve Bank of India (RBI) also plays a role in the estimation of NI of the country. Till some time back, both the CSO and RBI have been estimating savings, an important constituent of NI using different methods of calculation. With the view to eliminating discrepancies found in their calculations, they have now coordinated the practices. As per the new arrangement, the CSO now estimates savings of the household sector, taking into account physical assets and life funds, provident and pension funds, and the public sector. On the other hand, the RBI deals with other financial savings of the private corporate sector and household sector. Another role played by the RBI in estimating the NI is that it directly calculates inventory changes for the joint stock companies of the private corporate sector.’7

Advance Estimates and Quick Estimates of NI

Since the year 1992–93, the CSO has been releasing the advance estimates of NI at constant prices every year during January/February. ‘These estimates are based on advance estimates of agricultural production and partial information available in various sectors of the economy for part of the year, as the year is yet to close when advance estimates are released. The advance estimates are compiled by extrapolating the previous year’s quick estimates, when the growth rate is observed in each of the physical indicators of various sectors for certain part of the year.’9

It should be noted that the growth rates estimated during the current year of advanced estimates would be independent of the earlier year’s levels of estimates to a considerable extent. More accurate and updated data are available in June every year, when the advance estimates are revised. The estimates of NI from all sectors including the data obtained on the index of industrial production and other expenditures are compiled in the month of January every year, when detailed data from different sectors can be accessed by the CSO. Even these estimates are further revised in the ensuing years as the latest data keep on flowing from some agencies.

Difficulties in the Measurement of NI

Though the calculation of NI is of very great importance to measure the growth or decline in the economic growth of a country during a particular period, it is a task full of difficulties and complications. These difficulties mostly arise because of the lack of statistical information or due to data that are unreliable. Complications may also arise due to lack of understanding of the national accounting procedures. Such difficulties are more pronounced in the underdeveloped countries than in the developed countries. The following are the difficulties in the measurement of NI:

  1. Existence of a large non-monetized sector: The NI must be calculated in terms of money. But there are certain things including certain essential services, which are not exchanged for money. Some typical examples are unpaid personal services such as those of a housewife to her family; services that a man does for himself; free services obtained from the government or local authorities such as municipalities and panchayats; goods made for pleasure rather than for sale such as paintings; and goods consumed by people producing them such as the cultivator’s family consuming part of the produce. Items such as these could be sold but they are not sold because in these cases, the producers themselves are the consumers. Therefore, they are not valued in terms of money and as such excluded from the NI estimates. Such omission means that the NI is calculated in such a way that it is shown smaller than what it actually is.
  2. Paradox in assigning incomes: The measurement of the NI in terms of money brings about strange results in certain cases. If an employer engages a girl stenographer, her salary enters into the NI figures. But if he marries her after a year, the NI next year will be reduced to the extent of the stenographer’s salary because the businessman will no longer pay any salary to her as she is his wife.
  3. Exclusion of illegal activities: Income from illegal activities is not included in the NI. For example, the incomes of bootleggers, gamblers, prostitutes, etc., are not counted as part of the NI. But such products or services rendered by these people have utility in the economic sense and as such they earn incomes individually. The exclusion of such items results in an undervaluation of the NI.
  4. Unreliability of statistical data: NI is calculated on the basis of available statistical data. But such statistics are not always accurate. Even in very advanced countries, the available statistics are unreliable, inaccurate and, sometimes, unscientifically collected. This makes the figures of NI unreliable too.
  5. Changing values of parameters used: NIs of two or more years cannot be compared properly if we want to see whether it has improved or declined over a period because within this time, prices and other factors change.
  6. NI estimates are only approximations: NI estimates are only rough approximations and as such cannot be relied upon. Future forecasts of growth or planning based on such approximations will lead to wrong results.
  7. Non-maintenance of accounts by producers: Next difficulty arises from the fact that many of the Indian producers are not sure of the exact quantity arid the value of the products they produce. As a result, an assessment of output, and consequently incomes, produced by the illiterate, self-employed agriculturists, small producers and owners of household enterprises in the unorganized sector would require an element of guesswork. And where there is guesswork, the possibility of incorrect estimation of NI is very large indeed.
  8. Lack of occupational differentiations: The lack of distinct differentiation of economic functions constitutes a great obstacle to NI calculation in India. Because of the pressure of population on land and lack of work throughout the years, the farmer turns to other works such as weaving, poultry and dairy fanning. This overlapping of economic functions stands in the way of proper classification of distinct groups engaged in specific occupations. In the absence of a clear-cut, occupation-wise classification of people into distinct groups, the calculation of NI is extremely difficult.
  9. Lack of scientific data: More than all these difficulties, there is the great limitation of NI calculation, which arises out of the available statistical information. Whatever statistics are available, they are inadequate, incomplete and often misleading. The unscientific and often inaccurate manner in which the data are collected would necessarily lead to different interpretations and, often perhaps to wrong conclusions.

All these drawbacks call for a great deal of improvement in the calculation of NI of the country.

NI Data and the Changing Profile of the Indian Economy

The Indian economy has evolved since independence. In this section, we review the key features of the Indian economy and its relation to the NI of the country.

Characteristics of the Indian Economy

The following features of Indian economy can be observed from the NI data over the years.

Meagre Increase in Real NI

The real NI of India between 1951 and 2007 has increased at an annual average rate of 4 per cent. Considering the fact that during the same period, population increased at an annual average rate of 2 per cent, the per capita income has increased at the annual average rate of just 2 per cent. One could observe fluctuations in the year to year growth rates, especially in the early stages of development. Besides, the rate of growth in NI has been rather slow, much less than the conservative targets the Planning Commission had fixed. In terms of poverty, the eradication of which should be an important parameter of development, we have not achieved any degree of success. The population below poverty line was 54.9 per cent in 1973–74, while it came down to 26.1 per cent in 1999–2000 and to 19.3 per cent in 2007.8 However, a report (15 February 2010) titled ‘Achieving the Millennium Development Goals in an Era of Global Uncertainty’, brought about by the Asian Development Bank (ADB), the United Nations Economic and Social Commission for Asia and the Pacific (ESCAP), and the United Nations Development Programme (UNDP) has placed more than 400 million Indians in ‘extreme poverty’, subsisting on less than 1.25 USD a day, as a result of job losses combined with inadequate social protection following the global financial and economic meltdown.9

Structural Changes in the Indian Economy

The composition of GDP of an economy reveals the relative significance of the different sectors such as primary, secondary and services sectors. In a poor country, the primary sector that includes agriculture and nature-based activities predominate; very large percentage of people depends on it for their employment and livelihood. Their incomes are low, agriculture being a low-income-generating sector and as such, the NI of such countries is bound to be low. In the case of India, over the years, compared to the growth rate of the primary sector, the growth rates of the secondary ( manufacturing) and tertiary (services) sectors have more than doubled. In fact, the services sector contributing almost 57 per cent to the NI has become the growth driver of the Indian economy. The rapid growth of the services sector has wider implications for population, employment and trade prospects of the economy. It is imperative to devise suitable policy initiatives to introduce greater competition and efficiency, especially in software industry, to ensure its sustained contribution to exports and higher long-term growth. This is becoming increasingly important due to the global financial meltdown, increasing protectionism and severe competition from emerging players like countries in Eastern Europe, Vietnam and the Philippines.

Declining Share of the Public Sector

India being a mixed economy, there is a co-existence of both the public and private sectors. During the Nehruvian era, public sector was given a predominant role, whereas the private sector was given a step-motherly treatment. There was a phenomenal growth of the public sector in terms of both the number of units established and investments. This situation lasted till 1991 when their decline started. NI estimates show that the share of the public sector in GDP was 14.9 per cent in 1970–71; it rose to 25.9 per cent in 1993–94 and then declined to 23.2 per cent in 2003–04. As mentioned before, since 1991, the year when economic reforms started, government started reducing the role of the public sector and withdrawing from loss-making public sector enterprises. The trend continues even now.

Distribution of Income

Equitable distribution of income and wealth is very important for the orderly development of the nation. Inequalities of income between different population segments are likely to create socio- economic tensions in the society. Several academic and empirical studies have been made on the question of inequalities of income and almost all of them conclude that gross inequalities of income do exist in India. Moreover, NI estimates reveal wide disparities between rural and urban incomes. This disparity seems to be growing during the post-reforms period. Though the governments at various levels have a mandate to curb the growing inequalities through their direct participation in direct economic activity and policy interventions, these attempts of governments, of late, seem to be losing steam, especially during post-reform years. After 1991, the government has been withdrawing from direct participation and involvement in industrial development. It has very limited control over the predominant private sector. Besides, effective regulation and control of decentralized, market-based activities are found to be increasingly difficult for the government to pursue anymore.

Capital Formation and Savings in India

Economist Böhm von Bawerk (1851–1914) defined capital as ‘the produced means of production’, i.e., the stock of goods which are used in production and which have themselves been produced. It can also be defined as the net addition to the reproductive wealth of a country and measures part of the wealth, which is retained for use in future production. Several attempts have been made in India since the commencement of planned economic development to measure the size of the capital formation in the country. For measuring capital formation, the CSO employs the commodity flow method under which capital formation is measured from data on production, exports and imports used for investment purposes and from estimates of changes in stocks of these goods.

With regard to the calculation of savings that feed capital formation, the economy is split into three sectors and the savings from each of these is measured separately, sometimes employing different methods.

Rate of savings is measured as a proportion of GDP at market prices. The savings rate in India has been showing an erratic behaviour. Gross domestic capital formation as a percentage of GDP has been estimated at 36.3 per cent for the year 2007–08.10 The rate of savings on GDP in India was about 10.20 per cent in 1950–51. After 1972–73, there was a perceptible improvement in its growth at 16.30 per cent. Savings as a ratio of GDP rose to 26.0 per cent in 1979–80. After 1980–81, there was a decline in savings and it fell to 18.2 per cent in 1984–85. By 1992–93, it recovered to 22 per cent. The growth in the rate of savings continued to rise in the new millennium. For the year 2007–08, the net domestic saving accounted for 30 per cent of the NDP.11

The National Statistical Commission

The Government of India constituted the National Statistical Commission (NSC) in January 2000 under the chairmanship of C. Rangarajan, former Governor of the RBI, to study the problems involved in the estimation of NI in India and make suitable recommendations to be implemented. The NSC submitted its report on 5 September 2001.

The Commission has pointed out the major gaps in the Indian statistical system and non-availability of critical databases on Index of Industrial Production (IIP), Wholesale Prices Index (WPI), Consumer Price Index (CPI) and studies on cost of cultivation for major crops. The Commission has advocated suitable WPI and CPI at the state level and benchmark surveys of companies in the collection of statistical information; the Commission has also recommended that the Central Government should support the funding of Departments of Economics Statistics at the state level.

The NSC discussed, at length, the reasons for revisions in the national accounts statistics and made elaborate recommendations for improving the coverage and quality of database required in the compilation of national accounts. The recommendations of the NSC, when implemented, are expected to improve the data availability position as well the quality of the data presently available for compiling the national accounts, from various data sources.12

Limitations of NI Estimation in India

We have seen earlier that the estimating NI in developing countries is replete with difficulties and problems. India is no exception. There are several conceptual problems, in addition to certain limitations, such as (i) the existence of a large non-monetized sector; (ii) lack of data concerning the income of small producers and household enterprises; (iii) absence of data on income distribution; and (iv) unreported illegal income. However, the CSO has been making earnest attempts to improve the estimation of NI. Notwithstanding these attempts at improvement, it requires about four years to finalize NI figures for a particular year. As we have seen earlier, the CSO makes advance estimates, quick estimates, revised estimates and final estimates. Even after six decades of experience and a great deal of experimentation, there is still much to be done to achieve an acceptable degree of success in the estimation of NI in India.

Determinants of the Size of a Country’s NI

The size of the NI of a country, especially with reference to the per capita income of its citizens, is an index of its prosperity or poverty. There are more than 100 countries in the world today, which have very low NIs while a handful of countries such as the United States, the United Kingdom, West  Germany, Japan, Russia and France enjoy larger NIs which promote a higher standard of living for their people. Even among the underdeveloped nations, India has one of the lowest NIs in spite of her vast natural resources and abundant labour supply. India’s per capita income was only USD 820 in 2006 whereas the USA had the highest per capita income placed at USD 44,970 in the same year.’ There are certain factors that determine the size of the NI of a country. If these factors are favourable to the country, it will have a higher NI; if the factors are unfavourable, then naturally, the country’s NI will be lower. The size of the NI of a country is determined by the following factors:

  1. Natural resources: Nature supplies the main stimulus for development with its resources; countries which have sufficient land, fertile soil, suitable climatic conditions to grow and produce a variety of goods, necessary minerals such as coal and iron, oil and power, have the necessary capacity for a high NI; countries which have poor natural resources usually have low NIs. But the available natural resources must be properly exploited and used. There are many countries including India, which have abundant natural resources but remain poor because these are not properly and profitably utilized.
  2. The quality of people in general, and labour in particular: The quality of the people is a very important determining factor for the size of the NI. Their character, energy education, initiative and industry go a long way to improve a country’s economic development. Japan and Germany were almost destroyed during the Second World War but because of their character and industry, the people of these two countries enjoy a very high standard of living today. Labour, a part of the population, must be reasonably efficient to produce as much as possible. They must be properly educated, both generally and technically, and adequately equipped with the necessary machinery.
  3. Capital: The NIs of underdeveloped countries are low because of lack of capital. Capital is necessary to buy machinery and raw materials, to pay for labour, transport and for a variety of other purposes. The people of the country should save enough out of their incomes to initiate and diversify industrialization of the country. To mobilize the savings in villages as well as in towns, there should be necessary number of banks. Credit institutions are necessary to help industrialists and businessmen.
  4. Organization: Skilled management and organization, both in agriculture and industry, are vital for a high level of production and to achieve a high NI. There should be efficient and committed leaders to help the common people to better their lot. Inefficiency in agriculture and industry has led the underdeveloped countries to eternal poverty. For efficient organization, it is also necessary to have a properly developed and well-knit transport system and means of communication.
  5. Social and political structure: Social and political institutions may help countries to improve their NIs or prevent them from improving it. It is a well-known fact that the caste system and joint family system in India have prevented individual initiative and enterprise. Political stability, the existence of law and order, sound administration and above all the positive encouragement a government is able to provide to industrialists and traders, would all help NIs of countries to increase.

Reasons for India’s Low NI

The NI of India is one of the lowest in the world. Consequently, the average Indian has an income which is just enough to survive. Millions of Indians do not earn even the equivalent of one dollar a day. This is rather perplexing in view of the fact that India is rich in its natural resources. Several factors contribute to this appalling poverty and ridiculously low NI. They are detailed in the following sections.

Economic Causes

There are several reasons as to why there is so much of grinding poverty in India in spite of the fact the country is a veritable darling of nature in terms of factor endowments and natural and other resources. There are economic, political and social causes that have worked together to bring about this sorry state of affairs. These causes are explained below:

  1. Too much dependence on agriculture: About 60 per cent of India’s population is engaged in agriculture, either directly or indirectly. Moreover, in India, if the monsoon fails, agriculture fails, as a sizeable percentage of the total income, and therefore, production of the economy, is from this sector. There are several other industries that are dependent on agriculture; for instance, cotton textiles and jute industry, edible oil, soaps and detergents, transport and communication. If agriculture fails, it will have severe adverse impact and a chain reaction on these industries. Besides, Indian agriculture is traditionally inefficient because of the illiteracy of the farmers, lack of irrigational facilities, rural indebtedness, limited and often wrong use of fertilizers, small and scattered holdings and the general insecurity of crops. When the income of a sector that contributes a big chunk of the NI is so low, naturally the total income itself is very low.
  2. Lack of industrial development: As a legacy of the foreign rule, Indians lacked an industrial tradition. The early handicraft industries, which would have matured into modern industries as a result of an industrial revolution, were killed by the British. Moreover, the lack of enterprise and initiative of our countrymen, their lack of venturesomeness, domination of foreign capital in export industries, absence of basic industries and technical training facilities, the inadequacy of transport and banking services, the absence of Indian capital necessary to start new and diversify existing industries and other such unfavourable factors actors have prevented a proper and diversified industrialization of the country.
  3. Inadequate trade and transport services: Most of the Indian trade was concentrated on the export sector. The then prevailing barter system prevented an expansion of internal trade. The ascetic tradition of Indians, their production catering only for consumption rather than for the market, the widely prevalent self-sufficient village system for ages and the lack of price incentives coupled with the poverty of the consuming public restricted trade. As a result of smaller trade, markets were limited and production meagre. Besides, the lack of development of transport and communication facilities prevented the orderly expansion of production. When production is less, naturally the NI is less.
  4. Lack of banking and credit services: There is nothing more important to modern production than the availability of capital. It is proverbial to say that the Indian capital is shy, implying there is not enough capital in the country to maintain and develop new industries. In the absence of institutions of credit, industrialization suffered a further setback. There were not enough banking and financial institutions to channel even the low amount of savings available, especially, in the countryside.

Political Causes

The long foreign rule completely demoralized Indian people; they began to ape the Westerners in everything, looked to them for all guidance and hardly took any initiative to better their own pitiable lot. This perfectly suited the foreigners. They drained away the country’s wealth, destroyed the existing industries, exported all the commercial and industrial raw materials to feed the industries in England, and above all, they used India as a market to sell their finished goods. This heartless policy of foreigners coupled with the lethargy of Indians did not provide any scope for industrialization. Hence, there is low production and, thus, low NI.

Social Causes

The old and outdated customs, traditions, institutions and superstitious beliefs were no less responsible for the slow growth of Indian economy. The caste system, for example, has had an adverse influence on the economic progress of the country. The fatalistic and religious fanaticism of the people, the idea that is ingrained in the minds of the poor that whatever they do, they would not come out of the rut, because the heavens have decreed them so, their mighty satisfaction with the nearly little they have, lack of thrift and saving, are all largely responsible for the attitude of indifference on part of the people towards their own economic betterment. Further, mass illiteracy and conservatism have proved to be great hindrances to any economic advancement. As a result of all these factors working concurrently in the country and exercising a great influence on the economy, it is no wonder that the national and per capita incomes of Indians were almost the lowest in the world.


The poverty of the Indian masses needed a centralized comprehensive planning machinery to allocate resources, to fix targets and to accelerate economic development. The Indian Planning Commission has been trying its best to promote faster development and increase NI through a series of Five Year Plans. If these efforts have to bear fruits, many measures had to be undertaken with a long-range view. India being a predominantly primary producing country in which agriculture provides employment to millions of people, the agricultural base should be strengthened; and agricultural development should be speeded up by extending irrigational facilities, liberal supply of credit, distribution of cheap fertilizers, suitable equipment, etc.

On the other hand, industrial development also should be speeded up and diversified. This could be done by adopting a more encouraging industrial policy, by the provision of adequate industrial finance at reasonable rates, supply of raw materials necessary for certain special types of production, etc. The government must also encourage the existing industrialists to diversify their production of goods instead of concentrating on certain profit-yielding industries alone. More finance should be made available for the development of an orderly and extensive network of transport and communication system. Extension of banking facilities to mobilize the saving potentialities of the country and to a make them available to trade and industry also is an important necessity. Spread of free and compulsory education up to a certain level is of great importance. The poor students must be encouraged to educate themselves, both generally and technically. If all these measures are taken, then the NI of India will definitely increase.

NI and Economic Welfare

Economic welfare is a general sense of well-being that people experience when they earn and spend what they earn on goods and services. Generally speaking, NI and economic welfare are closely intertwined. It is normally assumed that if the size of NI is increased, economic welfare is also increased. An increase in NI would mean more goods and services available for consumption and this would definitely promote welfare of the citizens. Likewise, a fall in NI would mean a decrease in the quantity of goods and services which would bring down the economic welfare of the people. This generalization is, however, invalid under the following conditions:

  1. When there is a wrong priority of goods produced: In the process of gaining the NI, if the addition to the income is due to an increase in the supply of rich men’s goods and is gained at the cost of poor men’s goods, economic welfare would be adversely affected. It is because the resulting loss to the poor is more than the resulting gain to the rich.
  2. When the incomes reflect wrong facilities: An increase in NI must be reflected in better facilities and consumption if it has to increase the economic welfare of the people. Free libraries, savings banks, better entertainment centres for the poor, healthier resorts—all these would promote national welfare. But if the increase in NI is reflected by an increased number of pubs or lotteries, the taste for drinking or gambling will develop in people which would diminish their welfare.
  3. When the workers are overworked: If an increase in NI is obtained by overworking the country’s men or by exploiting women and child labour, then it would not bring about any economic welfare. The income obtained at the cost of the nationals’ health is no income at all.
  4. When income is generated under unhealthy conditions: If the increase in national dividend (income) is a result of inventions or improvements in administration, economic welfare would be increased. On the contrary, if the increase in national dividend is a result of additional work carried out under unhealthy conditions, then economic welfare will be adversely affected.
  5. When there is no increase in real incomes: An increase in national dividend may be accompanied by a rapid increase in population, which would reduce the earnings of workers. Likewise, an increase in national dividend may be due to rising prices, sometimes the increase may be entirely due to an increase in the production of commodities that the common man cannot consume such as defence goods. Often, NI shows an increase due to increased production of goods such as tobacco products, liquor, opium and LSD. Under these conditions, the per capita real income of the people will not increase much and to that extent national welfare may be affected.
  6. When there is an improper and uneven distribution: Changes in the distribution of national dividend should be done in such a manner that the poor are enabled to get more things at the expense of the rich. This can be done by taxing the rich heavily and passing on the benefits of taxation to the poor by means of free social services such as the provision of free educational and health services for the poor. But in the transference of such incomes, care should be taken to see that the size of the NI is not adversely affected.
  7. When income is earned at the cost of leisure: Income at the cost of leisure will not bring about any welfare. People are engaged in a rat race to make money and give up leisure. They have no time to sit, watch and enjoy the good things of life. This does not promote people’s welfare.

These are the conditions, which if favourable, would promote the national welfare with every addition to the NI. If not, every addition to NI may not bring about an increase in economic welfare.

Case 14.1: Developing Countries are Happier

Some of the world’s richest countries are not the happiest. Citizens of developing nations such as India, China, Pakistan and Bangladesh are happier and more satisfied with their quality of life than people in the UK, Australia, France and even the US, finds a study. A study by New Economic Foundation (NFF), a UK-based independent think tank, has placed countries including India, Bangladesh, China, Malaysia, Pakistan and Bhutan as having a higher ‘Happy Planet Index’ (HPI) than other developed nations.

HPI was calculated with data from 143 countries, covering about 99 per cent of the world’s population. Scores range from 0 to 100. High scores are achievable only by meeting three targets—high life expectancy, high life satisfaction and a low ecological footprint.

Life expectancy in India stood at 63.7 years, life satisfaction was rated at 5.5 and ecological footprint was 0.9, the overall HPI was 53. In countries of the ‘new world’, the life expectancy hovers in the 80s and even though the life satisfaction rate is very high, it is the high ecological footprints (varying from 5 to 9) that pull these countries’ HPI down. An ecological footprint plays a crucial part in the HPL. It uses the concept of ‘one planet living’, which embraces the principles of sustainability that determine a high quality of life while using a proportionate share of the earth’s resources. ‘The countries which tread heaviest in terms of ecological footprint are Luxembourg, the United Arab Emirates and the US. Luxembourg’s per capita footprint is equivalent to consuming natural resources as if we had almost five planets to rely on’, says the report. However, the countries with low ecological footprints whose low consumption patterns like Malawi, Haiti, Congo, Bangladesh, Tajikistan, Nepal, Zambia, Sierra Leone, Rwanda and Togo do not imply efficient use of resources but rather a lack of them.

What is interesting to note is though ‘whilst most of the countries studied have increased their HPI scores marginally between 1990 and 2005, the three largest countries in the world (China, India and the USA) have all seen their HPI scores drop in that time’, according to the report.

Source: Nidhi Mukundan (2009), ‘Developing Countries are Happier’, Times of India, Chennai, 9 July 2009, Reproduced with permission.

Inequalities of NI Distribution

The concept of NI alone does not have much significance unless it is also related to the distribution of the nation’s income. The owners of the factors of production get their rewards in the degree they have contributed to the total production. Labourers get their wages, landowners their rents, lenders of capital their interests and organizers their profits. But in the open-market system, some people have more command over these factors of production than others; some have more bargaining power; and some get higher rewards than others due to special circumstances. These factors lead to inequalities of income among the members of the society. Though inequality of incomes is the by-product of a free, competitive society, it is present even in a state-controlled, socialist society.


The causes of inequalities of income can be broadly divided into two: inborn and acquired. Individuals born into affluence have access to many more opportunities than their counterparts born in poverty. There are certain other causes that generate inequalities of incomes due to peculiar conditions and circumstances. They are as follows:

Inborn Inequalities

  1. Differences in intellect and physique: When people are born, they show an amazing degree of innate differences; some are dull and stupid whereas others are gifted with the highest genius; some are weak and delicate whereas others are strong and sturdy in physique and so on. These innate mental, physical and moral inequalities are often reflected in the inequalities of income. It is quite natural that one who is brilliant and steady in work would be better paid than another who is stupid and lazy. Those individuals who are more enterprising than others may take legitimate risks to earn more.
  2. Differences in sex: In most cases, women are paid lower wages than men for doing the same kind of work. This is so even in developed countries including the USA and UK. This is due to long-standing habit and custom. Besides, women except a small minority who are educated and live primarily in urban areas, do not make their work a life-career option as men do and as such do not fight to better their conditions by organizing themselves into trade unions. Again, men are supposed to be much more reliable for continuous and efficient work as they are physically stronger and can undertake more strenuous work than women. As a result, there are inequalities of income between women and men workers.
  3. Inheritance of property: The hard work and thrift of one generation brings fortune to successive generations, which would enjoy the fruits of the past labour. Inequality of property leads to inequality of earning power also. The resulting inequality in earning power contributes to further concentration of property in the hands of the same persons. So long as the system of inheritance and private property lasts, inequalities of incomes are bound to be present.

Acquired Inequalities

  1. Inequalities due to work: In many cases, incomes between persons tend to be unequal because of their work that might be different young, energetic and capable workers would be able to get more wages than old and physically incapable persons in certain occupations. Sometimes seniority, experience and the resultant capacity may determine the differences in wages. Sometimes, the locality of the workplace also would bring in inequalities of wages. People living in cold climate regions would be paid more than others in temperate climate regions; workers in a city would be paid more wages than those who work in villages; if people are trained to handle more expensive and complicated machines, they would be paid better than others.
  2. Inequalities arising out of the nature of work: Those people who are engaged in risky jobs get more wages than others. Deep sea divers, for instance, are paid handsomely because of the risk involved in their jobs. So are the pilots. If a job is not continuous, the workers are highly rewarded whereas those who are assured of a permanent and continuous job are not highly paid. If a job entails more responsibility, it pays more than others. The nature of goods produced would also determine the differences in wages. If the method and technique of production are advanced, then also the workers are better paid.
  3. Inequalities arising out of supply of and demand for labour: If the supply of labour is greater than the demand, then the wages would tend to be low and if it is lesser than the demand, wages would tend to be high. But the supply of labour itself would be affected by various factors. If a job is agreeable, the supply of labour will be larger and wages lesser than it would otherwise be. If a job is regular, the supply of labour would be greater than the demand, and wages would be low. On the contrary, if a job is very responsible, fewer people would offer themselves for it and consequently wages will be high. Likewise, if a job is sheltered through trade unions and exclusive associations such as the Pilot’s Guild, only limited number of people could be engaged and wages have to be on the high side. If more money, time and energy have to be spent on acquiring the necessary education, training, internship, apprenticeship, etc., for certain professions such as chartered accountants or cost accountants there would be fewer people than there would be the demand, and as a result, the remuneration would be high.

The following factors have contributed to the inequalities of income in the society.


Widespread disparities in income distribution are socially undesirable as they lead to class struggles and social turmoil. Inequality of income also leads to lavish expenditure by the rich while the majority of the people do not even get one meal daily. Concentration of wealth and income ultimately leads to concentration of political power accompanied by corruption, political pressure and favouritism. Above all, inequalities of incomes lead to economic instability. It has been the experience, all over the world, that wide disparities in income are the most important single cause of wild economic changes. That is why all the governments in the world try their best to reduce such disparities through various measures.

Capital Formation and Inequalities of Income

Classical economists including Adam Smith, Ricardo and Marshal justified inequality of incomes on the ground that it promotes capital formation. Frank William Taussig held the view that inequality of incomes is the economic expression of the natural inequality in talents; that inequality provides an inducement to people to advance themselves economically; and that inequality of income does not matter as long as the rich becomes richer and the poor do not become poorer. Besides, according to these economists, when there are a few rich people, they would save more than they consume and thus help in more capital formation whereas the poor people do not have the capacity to save. With more poor people, there would be more consumption and very few savings. Therefore, according to them, this would lead to little capital formation and consequently, stagnation of the economy. But, modern economists led by Keynes believe otherwise; according to them, it would lead to more investment by producers to get more profits out of more production. This would in turn create more incomes, more production, more employment and so on.

Steps Taken by Governments to Reduce Inequalities

Most modern governments have taken elaborate steps to reduce inequalities. In India, under the socialist pattern of society, the government has adopted various measures to reduce inequalities of income that are widely prevalent in the country. It is remarkable that after more than 66 years of independence and 63 years of planning, the inequality of incomes widening and most beneficiaries of the planned economic development are only politicians, bureaucrats and contractors. This has naturally forced the government to seek measures to reduce such terrible inequalities of income and wealth.

The Minimum Wages Act 1948 guarantees a wage high enough to maintain a minimum standard of living for agricultural labourers and others engaged in ‘sweated trades’. The Government of India also spends a lot of money, collected from the rich tax payers, to improve the conditions of the poor people through innumerable social security schemes. Through the public distribution system, the poor and low-income people are provided scarce and essential commodities such as wheat, rice, gas and kerosene at highly subsidized prices. It has extended to the poor people services including free education, free medical and maternity aid, old age pensions, sickness and accident compensations, provident fund schemes and social insurance up to a certain level. Poor students are encouraged to better their lot and that of their families through scholarships and other financial assistance. The rich are prevented from getting richer at the cost of the society by levying a heavy tax on their incomes, levies on articles of luxury they are likely to consume, and other duties such as death duty, estate duty, etc. These are some of the measures that are undertaken by the Indian government to reduce inequality of incomes in our country.

Uses of NI Data

According to the National Income Committee (1951), NI statistics provide a wide view of the country’s entire economy, as well as of the various groups in the population who participate as producers and income receivers, and that if available over a substantial period they reveal early, the basic changes in the country’s economy in the past.*

Modern governments take great pains to collect NI statistics for a variety of reasons. The purpose of such statistics is, of course, to see how far the country has progressed economically. If it has not progressed fast enough or if it has not progressed at all, certain measures would have to be taken by the government to improve the economic growth of the country. Moreover, NI data are useful or significant for the following reasons:

  1. For measuring economic welfare: NI data are used to measure economic welfare of the people. To a great extent, an increase in NI would signify an increase in the economic well-being of the citizens.
  2. For measuring per capita income: The per capita income of the poor people of a country is arrived at by dividing the NI by the number of people. This concept is very useful because if population increases in the same proportion as NI, then the economic well-being of the people has not improved.
  3. For measuring the standard of living: NI data give us an idea as to the standard of living of the community. The lower the NI, the higher would be the ills of the economy. Thus, it helps the government and the people to seek remedies to cure them.
  4. For comparisons over a time-period: By comparing NI estimates over a period of time, we can know whether the economy is growing, stagnant or declining. This would make the government adopt suitable policies to improve the NI in the following years.
  5. For measuring the savings-investment ratios: The NI data are used to assess the saving and investment capacity of the country. The rate of savings and investment would depend upon the NI of the country. At the same time, the greater the savings and investments, the greater would be the NI in the following years.
  6. For international comparisons: NI estimates are extremely useful to compare the standard of living of the people of one country with those of others. As a result, the richer countries of the world help the poorer countries whose NIs are low.
  7. For knowing sectoral compositions: NI data help us to find out the importance of the various sectors such as agriculture, industry and transport in the economy. When we know from the Indian NI estimates that services sector contributes more than 55 per cent to the total income of the country, we tend to give more emphasis to the services sector in the Five Year Plans.
  8. For economic forecasting: The NI data also offer a reasonable basis for forecasting future economic events. This will enable the country to foresee the likely results of a particular economic policy.
  9. For knowing the income distribution: Another use of the NI data is that they help us understand the distribution of the country’s incomes among different classes of people such as the rich, middle-class and the poor. Nowadays, all governments try to reduce the income-gap between the ‘have’s’ and the ‘have not’s’; and this task is not possible without the aid of NI data.
  10. For economic planning: The NI data are used for planning economic development of the country. Planning will be impossible in conception and unthinkable in execution in the absence of correct and reliable statistical information on NI over different periods.
  11. For correcting regional imbalances: NI data also help us realize the imbalances existing in the various regions of the country. As a result, steps can be taken to correct such imbalances in future through suitable governmental policies.
  12. For studying product-components: In war time, the study of the product components of NI showing which products have greater importance in the contribution of NI is very important, because they show the production possibilities of the country.

Standard of Living

With reference to a person, a family, or a body of people, standard of living means the extent to which they can satisfy their wants. If a group of people can afford only the minimum amount of food, clothing and shelter, their standard of living is said to be low. If, on the other hand, these people are able to afford sumptuous food and costly clothing, live in well-furnished houses and enjoy other comforts and luxuries, then they enjoy a high standard of living.

The standard of living of a community is indicated by the nature of their consumption. It is a concept denoting the material well-being to which an individual or social group is accustomed to. In other words, it is the aggregate of the level of necessaries, comforts and luxuries which a community has been enjoying. Both the quantity and the quality of goods consumed determine the standard of living. People when habituated to a particular mode of living would not want to lower it. Therefore, they will resist any rise in the price and try to get higher wages in order to neutralize the rise in the cost of living to maintain their standard of living. A person’s standard of living tends to stabilize over a period of time. Lowering the standard of living is difficult for individuals and families. This becomes evident in times of economic upheaval such as the Great Depression of the 1920s and the more recent global financial meltdown during 2008–09.

There is a distinction between standard of life and standard of living. The former represents the values and virtues that govern one’s life whereas the latter represents the necessaries, comforts and luxuries one gets used to get in one’s life. Abraham Lincoln and Mahatma Gandhi had high standard of life but a poor standard of living.

Factors Affecting the Standard of Living

The standard of living is determined primarily by the level of income of a household. The higher the income, the higher is the standard of living. If a person is promoted, he/she will seek more comforts; his/her standard of living will go up. Similarly, if the national income (NI) of a country goes up, people will have, in general, a higher per capita income. The higher the per capita income, the larger the volume of goods and services people can buy. A poor country concentrates on improving the standard of living of its people. A country can achieve this goal successfully only if it is able to raise its NI. The standard of living depends not only upon the income but also on the use it is put to. For example, if a school teacher and a labourer have the same income, the teacher spends his income very carefully on rent, provisions, milk, the education of his children, clothes and so on. After satisfying the most urgent needs of his family, he spends a few rupees, if possible, on entertainment. With systematic planning, he is able to maintain a decent standard of living with his meagre income. In contrast, the labourer who gets the same amount either gambles it away or spends it on liquor and cinema, making it impossible for him to purchase even the bare necessaries for his family. The wisdom with which people spend their income is, therefore, very important in determining the standard of living.

Apart from the size of NI, another important determinant of the standard of living is the manner in which the NI is distributed. People in developing countries are poor because the NI as an average per head is low. Wide differences in the standard of living of people in the same country are the result of unequal distribution of the NI. For instance, India has some of the world’s richest billionaires and several thousands of millionaires who spend their enormous wealth in conspicuous consumption. In the same country, more than 42 per cent of the population lives on hardly 1.25 dollars a day, according to the 2005 World Bank report illustrating the wide disparities in the standard of living in the country.6

The Standard of Living in India

Everybody knows that the standard of living of the vast majority of people in India is extremely low. The per capita annual income of India is one of the lowest in the world. It was only USD 950 in terms of per capita GNI for 2007 as against 46,040 for the USA and 37,670 for Japan. For most people, to get sufficient food twice a day is a luxury. About three-fourths of the people in India have one meal a day. Look at the pavement dwellers and the slum dwellers in Mumbai and Chennai. The huts become cold in the winter, hot in the summer and wet, even flooded, in the rainy season. Even then, millions of people reside in such slums. For many people, even such a shelter is not available. In the rural areas, people do not even get basic amenities such as clean water for drinking. When most people do not have the basic necessaries, it is easy to understand that comforts and luxuries are beyond their reach.

The main cause for this extremely low standard of living is the increasing rate of population growth. The per capita income can be stepped up either by raising the NI or by reducing the population or by both. (When we divide the total NI by population, we get the per capita income.) If population grows very rapidly and production increases very slowly, the increased population will nullify all the increase in the NI. That is exactly what is happening in India today. The population increases every year by almost 18.14 million whereas the growth in the NI does not match it. We have certainly made rapid progress in various fields of economic activities through economic planning but all our economic progress is being eaten up by the rapid growth of population. Unless all-out efforts are made to check the population growth, the standard of living of our people will not improve in the near future.

The problems of overpopulation and low economic growth cause a series of problems. The percentage of literacy in India is low. Consumption levels are miserably poor. As pointed out earlier, around 42 per cent of the Indian population lives below the poverty line on less than 2 USD a day. The low level of income of the average Indian manifests itself in his failure to secure a balanced diet, which in turn, causes low calorie intake and low level of consumption of protein. According to the National Sample Survey Organization’s (NSSO) data of 2004–05, ‘population reporting a calorie intake level of ‘less than 100%’ of the norm of 2700 kcal, formed 66 per cent of the total in rural areas and 70 per cent of the total in urban areas’. Another health issue relates to the poor intake of protein. The NSSO data also reveals that ‘the average daily intake of protein by the Indian population has come down from 60.2 to 57 grams in Indian villages between 1993–94 and 2004–05 and remained at around 57 grams in the urban area during the same period.’ In food consumption in India, cereals predominate whereas the diet in developed countries is rich as it contains a generous helping of fruits, fish, meat, butter and sugar. ‘The per capita availability of milk in the country (245 gm per day) is lower than the world average (285 gram per day) despite the fact that India is the second largest producer of milk in the world.’ In the area of public health, the situation is still worse. For every 10,000 Indians, there is one doctor. In contrast, Australia has 249 doctors for every 10,000 people, Canada has 209, UK has 166 and USA has 548.9. According to the Planning Commission, the country has a shortfall of 600,000 doctors, one million nurses and 200,000 dental surgeons. This shortfall has led to a dismal patient–doctor ratio in the country. Most of the problems arising out of poverty, which is the root cause of low standard of living, can be addressed successfully only with the spread of education. According to World Bank indicators, nearly 60 per cent of the Indian mothers are malnourished and an equal percentage of children are severely undernourished. According to the Census of 2001, ‘only 36 per cent of the households had access to safe drinking water, implying tap water. This results in developing less strength to fight diseases and is also partly responsible for the low level of efficiency of the Indian workers.’ With regard to housing, the situation is equally bad. As per the 2001 Census, only about 52 per cent of the households had permanent houses, whereas 30 per cent had only semi-permanent houses and the rest only temporary dwellings. Another telling picture painted by the same Census was that 34.5 per cent of the households did not own any of the assets such as radio, transistor, television, telephone, bicycle, scooter and motor cycle or moped. People must get proper education. They must know how to spend their limited income carefully. That will help the vast majority of people to maintain a reasonable standard of living with the limited amount of income at their disposal.

Engel’s Law of Family Expenditure

We will now turn to an interesting economic law based on the consumption pattern and standard of living of the people. In 1857, Ernst Engel, the head of the Prussian Statistical Bureau, prepared family budgets of different types of people in Germany. A family budget gives the detailed income and expenditure of a family on various items during a month or a year. It included all sources of revenue and all items of expenditure (i.e. food, clothes, milk, education, entertainment, etc.) in a detailed manner. Engel selected three income groups in German society-working class, middle class and the well-to-do class. From his study of their family budgets, he derived certain important conclusions, which constitute ‘Engel’s Law of Family Expenditure.’ His findings were as follows:

  1. As a person’s income increases, the percentage expenditure on food and other necessaries decreases. In other words, as a person becomes richer, he spends a decreasing percentage of his income on food and other necessaries of life.
  2. As a person’s income increases, the percentage expenditure on items of comforts and luxuries also increases. This follows from the first law.
  3. A person’s percentage expenditure on clothing is almost the same. Whatever be the level of income, his percentage expenditure on housing (i.e. rent), fuel and light too remains almost the same. Engel held that the percentage of a household’s expenditure on food is a way of measuring the standard of living: the lower the income, the greater is the percentage spent on food.

While examining Engel’s laws of family expenditure, we must remember that they refer to percentage expenditure and not to absolute expenditure. Whenever a person’s income goes up, his absolute expenditure on food and other necessaries of life certainly increases. The fall is in the percentage expenditure only. For instance, when a person gets INR 1000 per month, he spends (suppose) INR 800 on food. This is 80 per cent of his expenditure. When he starts, let us suppose, getting INR 10,000 income per month, he undoubtedly spends more than INR 800 on food. Suppose he spends INR 2000 on food (he may consume better-quality food). This constitutes just 20 per cent of his income. In the case of items of comfort and luxuries, not only the absolute expenditure but also his percentage expenditure increases.

Engel’s law is a very important generalization about the nature of consumption. The law is only a statement of truism. People generally spend a smaller share of their budget on food as their income rises. This is because of the fact that food being a necessity, poor people spend most of their incomes on it to satisfy their hunger. As people get richer, they may spend on better quality of food which may cost them slightly more than earlier. That is to say, they may spend more quantitatively on food and other necessities but as a percentage of total income, there is a definite drop in the expenditure on these items. With more money still left, they spend it on comforts and luxuries. Engel’s law is a universal law in the sense that in all countries, even now, it holds good. The law shows the general tendency of people and is true in all cases and in all countries.

Scales of Preferences

Economics is a science that is centred on the problems of choice—how best to meet human wants with the limited resources, which have several uses. Economic theory assumes that in exercising this choice, man acts rationally with a view to attaining maximum satisfaction. Faced, therefore, with a choice between two things, a person will choose the one that will give him the greater amount of satisfaction. This clearly shows that he has a scale of preference, a kind of list of his unsatisfied wants arranged in order of satisfaction. A commodity near the top of the list would give him more satisfaction than the one which is lower on the list. People may not even be aware of their having scales of preferences, but they do act on them when they buy some things first and postpone the buying of other things when they have limited incomes. They are, aware of the fact that some wants are more pressing than others. Whatever be the awareness of people in this regard, we do assume in economic theory that everyone has a scale of preferences, as one person’s scale will be quite different from another’s. Each scale represents the preferences of an individual irrespective of ethical or moral considerations.

Savings and Investment

Saving is that part of one’s income which is not spent but set aside either for future spending or for investing in property or securities. Saving is not to be confused with hoarding. It involves the productive use of the funds not spent on present consumption. Saving is one of the determinants of income and employment.

The total volume of saving depends on the size of income, its distribution, the capacity of the people to save and the rate of interest. Its economic importance lies in its relationship to investment. Saving is a necessary prerequisite of investment.

Investment has two related meanings:

  1. 1. In economic theory, it is generally taken to mean the actual production of real capital goods. Thus, the construction of a railway and the erection of new factory buildings are examples of real capital investment.
  2. As a financial term, it refers to the purchase of stock exchange securities or government securities or the deposits with banks or other financial institutions with the aim either of securing a regular income or the refund of a greater sum at some future date.

Classical economists assumed that saving and investment are equal at any point of time. However, in actual practice, this may not be so because saving is undertaken by one group of people and investment by another, and for different reasons. Those who save generally do so for meeting unforeseen contingencies, providing for some future purpose, such as for old age, education of children, starting of a business venture, or in the short term, to enable them purchase expensive goods. More importantly, savers are gullible; their decisions to save can be easily swayed by false promises by persons and institutions who want their savings. Investors, on the other hand, invest for realizing profits, when they expect an equal or higher rate of profit than the prevailing rate at which they could secure investible fund. Investors are more professional and their investment decisions are based on more logical and professional considerations. Though there could be ‘leakages’ between saving and investment, an economy should aim at stopping these. Equality of saving and investment are required because if saving exceeds investment, there will be less than full employment and if investment exceeds saving, there will be a rise in the level of prices. According to Keynes, saving and investment must always be equal because the amount of incomes generated by investment would provide an equivalent amount of saving. Keynes demonstrated this equality between saving and investment as follows:

If we take the NI (Y) to be the total of all incomes derived from economic activity, personal income is either spent on consumer goods (C) or saved (S). Thus, Y = C + S. Hanson summarizes this equality of Keynesian saving-investment theory as follows:

NI = Amount spent on consumers’ goods + Amount saved


Income = Consumption + Saving


Saving = Income − Consumption

Taking the NI, in real terms, as the total volume of production that comprises consumers’ and producers’ goods (real capital or investment):

NI = Amount of consumers’ goods produced + Amount of capital goods produced


Income = Consumption + Investment


Investment = Income − Consumption

As both saving and investment are equal to the difference between income and consumption, they must, therefore, be equal to each other. Therefore,

Saving = Investment

Key Terms

Barter exchange 135

Central statistical organization 128

Depreciation 114, 119

Domestic production by industrial origin 128

Economic welfare 137

GNP 113

Inequalities of income 132, 139

National income 113

Natural resources 134

NNP 113

Per capita income 115

Personal income 115

Subsidies 115

Unequal distribution 144


Discussion Questions

14.1. Define national income. Distinguish between gross national product and net national product.

14.2. What is national income? How is it measured?

14.3. In what three ways can national income be measured? Why are the three methods sure to give the same answer apart from small errors?

14.4. ‘National dividend is at once the aggregate net product of and the sole source of payment for all agents of production within the country’. Discuss.

14.5. ‘National income consists of a collection of goods and services reduced to a common basis by being measured in terms of money’. Comment upon this statement and discuss the view that the national income provides the best single measure of a nation’s economic progress.

14.6. What is the importance of national income estimates to a country? Write a note on national income and economic welfare.

14.7. Why is the national income of India low? Analyse the causes of inequalities of income distribution and suggest measures to deal with them.

14.8. Define and explain national income.

14.9. What are the different concepts relating to national income? Why are they significant?

14.10. Write a note on the standard of living. Why is the standard of living in India low?

14.11. State and explain the Engel’s Law of family expenditure.

14.12. What do you understand by the scale of preference? Why is it important in economic theory?

14.13. Define saving and investment. Why does Keynes argue that there should be equality between the two?



1. Marshall Alfred, (1890), The Principles of Economics (Cambridge: Cambridge University Press).

2. Arthur Cecil Pigou (1932), Economics of Welfare (London: Macmillan and Co.).

3. Fisher, Irving (1906), Nature of Capital and Income (New York, NY: Macmillan and Co.).

4. Makota, Kojima (1996), ‘An Essay on National Income Statistics of India’, Newsletter of the Asian Historical Statistics Project, Tokyo: Institute of Economic Research, Hitotsubashi University, No. 2, July 1996. No. 2.english/kojimae.htm.

5. Ibid.

6. Datt, Ruddar and Sundaram, K. P. M. (2007), Indian Economy (New Delhi: S. Chand & Company Limited).

7. Ibid.

8. Tata Services Ltd (2008), Statistical Outline of India 2007–08 (Mumbai: Tata Services Ltd), March 2008, p. 266.

9. Prime Sarmiento. Global meltdown wipes out Asia’s Gains, The Hindu, 18 February 2010, available online:

10. Tata Services Ltd (2008), Statistical Outline of India 2007–08 (Mumbai: Tata Services Ltd), March 2008, p. 266.

11. Tata Services Ltd (2008), Statistical Outline of India 2008–09 (Mumbai: Tata Services Ltd), March 2008, p. 24.

12. Government of India (2002), Methodology for Computing Advance Estimates and Quick Estimates of National Income (New Delhi: Press Information Bureau), 5  February 2002.

13. Tata Services Ltd (2008), Statistical Outline of India 2007–08 (Mumbai: Tata Services Limited), p. 266.

14. Mankiw, Gregory (2006), Principles of Economics (Thomson: South-Western Division of Thomson Learning); and Sloman, John (1999), Economics, Third edition, Prentice Economics (Europe: Prentice-Hall).

15. Smith, Adam (1937), An Inquiry into the Nature and Causes of Wealth of Nations (New York, NY: Random House).

16. Ibid.

17. World Bank, ‘New Global Poverty Estimates-What it means for India’., contentMDK:21880725-pagePK:141137-piPK:141127,theSitePK:295584,00.html

18. Tata Services Limited (2009), Statistical Outline of India 2008-09 Mumbai: Tata Services Limited, 2009, p. 266.

19. Census of India 2001, Series I, Paper I of 2001, Provisional Population Totals, Cited by Datt, Ruddar and Sundaram, K. P. M. (2009) Indian Economy (New Delhi: S. Chand & Company Ltd, p. 42.

20. MandaI, Sukanta (2009), ‘India Teeters on the Brink of Food Crisis’, Liberation, September 2009, liberation year_2009/sept_09/feature.html.

21. Commodity Online, ‘India milk output to reach 111 mtn by 2010,’ Commodity Online, 17 September, 2008,

22. Datt, Ruddar and Sundaram, K. P. M. (2007), Indian Economy (New Delhi: S. Chand & Company Ltd).

23. Ibid.

Suggested Readings

14.1. Ackley, G. (1978), Macro Economics: Theory and Policy (New York and London: Macmillan and Collier Macmillan).

14.2. Allen, R. G. D. (1969), Macroeconomic Theory (New York, NY: St. Martin Press).

14.3. Backerman, W. (1968), ‘National Income’. An Introduction to National Income Analysis (London: ELBS & Weldernfeld and Nicholson).

14.4. Bhaduri, A. (1990), Macroeconomics: The Dynamics of Commodity Production (New Delhi: Macmillan India Limited).

14.5. Branson, W. H. (1992), Macroeconomics Theory and Policy, third edition (New Delhi: Harper Collins Publishers India Pvt Ltd).

14.6. CMIE (1994), Basic Statistics Relating to the Indian Economy, Vol. I, August 1994.

14.7. CSO National Accounts Statistics (2009).

14.8. Economic and Political Weekly Research Foundation. National Accounts Statistics of India, 1950–51 to 2000–01, 2002.

14.9. Edey, Harold C., Peacock Altan, T and A. Cooper Donald (1967), National Income and Social Accounting (London: University Library).

14.10. First Report of the National Income Committee, April, 1951. Government of India, Economic Survey (2007–2008) and Government of India, Economic Survey (2008–2009).

14.11. Mankiw, N. G. (2000), Macroeconomics (New York, NY: Macmillan Worth Publishers).

14.12. Ruggles, R. and Ruggles, N. (1956), National Income Accounts and Income Analysis (New York, NY: McGraw-Hill Book Company Inc.).

14.13. Studenski, Paul (1977), The Income of Nations (Part II): Theory and Methodology (Delhi: Khosla and Co.).

14.14. Rao, V. K. R. V. (1983), India’s National Income 1950–1980 (New Delhi: Sage Publications India Pvt. Ltd.).

14.15. Bhaduri, Amit (1990), Macroeconomics: The Dynamics of Commodity Production (New Delhi: Macmillan India Limited).

14.16. Mankiw, N. Gregory (2000), Macroeconomics (New York, NY: Macmillan Worth Publishers).

14.17. Stonier, Alfred William and Douglas C. Hague (2004), A Textbook of Economic Theory, Fifth edition (New Delhi: Pearson Education).


* Economic Times, Chennai Edition, dated 10 April 2012.

Tata’s statistical outline of India 2008–09.

* First Report of the National Income Committee, April 1951, Page 6.