WEALTH AND CONSUMER HORIZON: EVIDENCE FROM A DEVELOPING ECONOMY

Abstract

This paper presents new evidence on the length of consumer horizon, which represents an important aspect of the Permanent Income Hypothesis. It uses data on private wealth of India for 1949-50 to 1974-75. Time varying parameter estimation is used to derive annual values of consumer discount rate and horizon. The findings support Friedman's view that is approximately three years long. The author discusses the plausibility of his findings. Two types of tests have appeared in the literature to examine the validity of the Permanent Income Hypothesis (PIH). The first type of tests has addressed the relevance of the strict version of the PIH, viz., that the permanent consumption is proportional to permanent income and that the marginal propensity to consume out of transitory income is close to zero. The second type of tests has examined the length of the consumer to see if it was longer than one year and thus the policy implications of the PIH were indeed different from the ones derived from the Keynesion type Absolute Income Hypothesis. Since the PIH has exciting policy implications for the savings efforts in underdeveloped countries several attempts have been made to understand the relevance of this theory in the context of underdeveloped countries. However, most of the studies thus far have been confined to the first type of tests. As yet no suitable attempt appears to have been made to calculate the length of the consumer to see if it is equal to or longer than one year. At the very outset it may be noted that the term horizon in the PIH has a quite different meaning from what it usually does. As it has generally been used horizon implies a cutting off point-that a consumer does not look beyond, say, three years if that is the length of his horizon. In other words, in the usual parlance implies a planning period. However, in relation to the PIH (Friedman, 1958, 1963) it means that it is the dividing line between effects he (consumer) considers transitory and those he considers permanent; that he will not adjust his consumption pattern to actual or possible changes in circumstances except as these can be expected to affect his consumption possibilities for a period longer than three years; and hence he definitely does look beyond three Note: I am grateful to Moses Abramovitz for several helpful comments on an earlier version of this paper. I am also thankful to a referee of this journal and the Managing Editor for many useful comments. To Mr. Jagdish Kumar, former Director of National Income Accounts at the Central Statistical Organization in New Delhi, I owe a special debt for his help in collecting data for reproducible tangible wealth of India. I am also thankful to Ela Trivedi for computations reported here.