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I am reading an article in the Economist.

It is discussing the China's unbalanced economy especially the lower household consumption proportion in GDP than the global average. The writer thinks the poor social safety net in China plays a part in curbing the household consumption.

Then follows the below sentence.

As low-income earners have a higher propensity to spend, the lack of support weighs on consumption more generally.

I don't quite understand why low-income earners have a higher tendency to consume.

I can't find any other supporting details in the article as if the writer takes it as a common sense.

Anybody could help to shed some light on it?

Thanks.

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    $\begingroup$ I recently watched Why It's More Expensive To Be Poor on Youtube. It's not a full answer to your question, and highly US-centric, but it may offer some insights. $\endgroup$
    – marcelm
    Sep 23, 2020 at 9:07
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    $\begingroup$ It could be something psychological: Compensating the feeling of being poor by consuming. Perhaps that is common sense/belief in writers background. Also, judging from some of my acquaintances, perhaps not too far fetched. $\endgroup$
    – Martin
    Sep 23, 2020 at 15:28
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    $\begingroup$ Just as an example: here in the U.S., a standard Costco membership (a membership-based store chain) costs \$60, while an Executive membership costs \$120. The Executive membership has a 2% rewards program, which means you get 2% of whatever you spent that year back as a gift certificate that year. So those who can afford to spend \$6,000+ per year there (\$116+ per week), they get their membership for essentially free, whereas those who can't have to spend at least \$60 per year in membership fees. $\endgroup$
    – gparyani
    Sep 23, 2020 at 17:45
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    $\begingroup$ @gparyani Add to that the additional 2% you can get back using the Costco credit card, which of course you have to be reasonably well to do to qualify for... $\endgroup$
    – Joe
    Sep 23, 2020 at 22:42
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    $\begingroup$ The premise is manifestly untrue if it relates to absolute spending. It only makes sense if it relates to spending relative to the size of a household's income, i.e. poor households spend a higher percentage of their income than rich households do. The answer is trivial: If you have to scrape pennies together to feed yourself, there remains nothing to be saved. $\endgroup$
    – henning
    Sep 24, 2020 at 11:44

7 Answers 7

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Marginal propensity to consume is the proportion of an aggregate raise in pay that a consumer spends on the consumption of goods and services, as opposed to saving it. If someone gets extra income $\\\$1000$ and consumes $\\\$750$ of this additional income their marginal propensity to consume is 0.75.

The marginal propensity to consume is higher for poor people since they have to devote higher share of an income to necessities. Suppose that person needs to spend at least $\\\$500$ a month for their living expenses. Now in such situation if a poor person would get a $\\\$500$ of income per month (relative to situation when the person would have nothing) they will have marginal propensity to consume 1 whether such person likes it or not as all additional income they get will be spend on these necessities. Person whose income would increase $\\\$1000$ (again relative to 0) will have to have at least marginal propensity to consume 0.5 and person with income increase of $\\\$10000$ (again relative to 0) at least marginal propensity 0.05. Of course, the richer people wont consume only necessities but the point is that as peoples incomes decrease the necessities become higher share of their budget.

At the same time as people get richer they spend a smaller proportion of their income as they already enjoy a high standard of living and thus are able to devote more of their income to savings. You can read more about this in Blanchard et al Macroeconomics: a European perspective or any other macroeconomic textbook.

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    $\begingroup$ "Marginal propensity to consume is the share of income that is devoted to consumption." Isn't that average propensity to consume? $\endgroup$
    – Adam Bailey
    Sep 22, 2020 at 13:25
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    $\begingroup$ Cheaper goods are also often more expensive in the long run (eg: a good pair of boots might last 10 times longer while not costing 10 times more), meaning that people who can't afford the higher cost item will end up spending more than a richer person. $\endgroup$
    – JS Lavertu
    Sep 22, 2020 at 20:37
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    $\begingroup$ @JSLavertu Yeah, I remember this as the "Boots theory". Do you know how it's called in economics / more formally? $\endgroup$
    – user
    Sep 23, 2020 at 0:20
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    $\begingroup$ @Pat-Laugh I've heard it referred as "Samuel Vimes 'Boots' theory of socioeconomic unfairness". $\endgroup$
    – JS Lavertu
    Sep 23, 2020 at 0:55
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    $\begingroup$ @Michael Buying a car is a good example. If you can buy a reliable car, you'll have many years with minimal maintenance costs. If you can't, you'll be stuck with a beater that breaks all the time, burdening you with massive repair costs constantly. Buying in bulk is a good example too: the cost is much lower per unit, but you need the cash upfront and space to store the extra items. $\endgroup$
    – JS Lavertu
    Sep 23, 2020 at 12:40
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Have you ever heard of 'living paycheck to paycheck'? It's another way of saying the person spends all the money they take in.

How many millionaires live paycheck to paycheck? How many poor people? The obvious answer is that it will be much more common the lower your income is.

At the extreme case, if your income is just dollars per day you will be spending 100% of it on food just to get enough calories for survival. On the other end of the spectrum, a billionaire would find it nearly impossible to spend money fast enough to run out.

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Suppose a poor person finds \$100 on the floor and a rich person also finds \$100 on the floor. The poor person will probably spend more of that \$100 than the rich person. We say then that the poor person has a higher (marginal) propensity to spend.

(The above idea is mentioned in most introductory economics courses and textbooks, so while it may or may not be "obvious" common sense, The Economist probably assumes that most readers are familiar with it.)

Response to comments:

I thought OP was possibly unfamiliar with a commonplace idea mentioned in most introductory economics courses/texts. So my answer was meant merely to quickly point OP to such discussions, without much elaboration.

I also thought there was the possibility that OP was already familiar with this idea, but was confused by The Economist's omission of the key word marginal, and thought that The Economist was claiming that poor people spend more in absolute terms than rich people. In which case my quick answer would resolve this confusion.

This idea has been commonplace since at least Keynes (1936):

men are disposed, as a rule and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income.

Of course, the extent to Keynes's assertion holds in the real world is an empirical matter and perhaps worthy of a separate question. (I believe it is mostly true, given the qualifier as a rule and on the average.)

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    $\begingroup$ This is a sensible theory, but needs to be tested empirically. There is evidence that a large number of people on low incomes are elderly with a low propensity to spend extra money $\endgroup$
    – Henry
    Sep 22, 2020 at 9:13
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    $\begingroup$ Question: "I don't quite understand why low-income earners have a higher tendency to consume." Your answer: "The poor person will probably spend more of that" seems to be a rephrasing of the question, without explaining the why? $\endgroup$
    – Giskard
    Sep 22, 2020 at 9:24
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    $\begingroup$ The problem with this answer versus 1muflon1’s is that this is a marginal propensity to consume. What matters here is the propensity to consume out of total disposable income. The need to pay for necessities is a key driver of that. $\endgroup$
    – Brian Romanchuk
    Sep 22, 2020 at 11:56
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    $\begingroup$ @Giskard With this kind of answer, the hope is that the rephrasing makes the why obvious. $\endgroup$
    – user253751
    Sep 22, 2020 at 17:31
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    $\begingroup$ I agree with most comments here. To me, the idea mentioned seems only "obvious" for a really struggling person with unmet needs, not necessarily a poor person (low revenue). I can easily imagine a rich person spending it all with no care to celebrate their luck, and a poor person saving this money, like they'd save every extra cent they can have. $\endgroup$
    – user
    Sep 23, 2020 at 0:18
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This is about the ratio of spending to saving. It does not mean that low-income earners spend more money than high-income earners. It means that low-income earners spend, as opposed to save, a greater proportion of their earnings.

Broadly generalising, the reason for this is straightforward: if the bill for a person's rent, food, and other basic expenditure is a very large proportion of their income—or indeed greater than their income—then they will not be able to save any significant proportion of their income or, in some cases, anything at all. In other words they will spend a higher ratio of their earnings than people who earn a lot. High-income earners have the luxury of having money to be able to save, and so many of them do. Therefore, they spend a lower proportion of their income.

In short, low-income earners spend a higher proportion of their income as opposed to saving it. This does not mean that they spend more actual money (dollars, euros, roubles etc) per person than other earners. Quite the reverse.

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    $\begingroup$ The OP may be expecting that this will be offset by the low-income person purchasing cheaper alternatives. A rich person lives in an expensive home and eats steak, a poor person rents an apartment and eats chicken. However, there's a limit to how much you can reduce costs. $\endgroup$
    – Barmar
    Sep 23, 2020 at 14:04
  • $\begingroup$ @Barmar Yes, quite right. $\endgroup$
    – Araucaria - Not here any more.
    Sep 26, 2020 at 1:51
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It's expensive to be poor. Not being able to meaningfully save money for a big purchase means that you lose the potential financial benefits that big purchase might have given you.

This is (humorously) illustrated by Terry Pratchett's fictional character Sam Vimes, in the book Men At Arms:

The reason that the rich were so rich, Vimes reasoned, was because they managed to spend less money. Take boots, for example. He earned thirty-eight dollars a month plus allowances. A really good pair of leather boots cost fifty dollars. But an affordable pair of boots, which were sort of OK for a season or two and then leaked like hell when the cardboard gave out, cost about ten dollars. Those were the kind of boots Vimes always bought, and wore until the soles were so thin that he could tell where he was in Ankh-Morpork on a foggy night by the feel of the cobbles. But the thing was that good boots lasted for years and years. A man who could afford fifty dollars had a pair of boots that'd still be keeping his feet dry in ten years' time, while the poor man who could only afford cheap boots would have spent a hundred dollars on boots in the same time and would still have wet feet. This was the Captain Samuel Vimes 'Boots' theory of socioeconomic unfairness.

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Try to connect to your personal experience or to that of people you know regarding living expenses and relevant fees. If you or your peers are earning-relatively-low income then it’s highly likely that the better part of that -relatively-small amount is spent rather than saved. Another way to state that fact is by saying that you or your peers or people at the low end of the income distribution in general, enjoy a high propensity to consumption (out of income, that is).

Usually, that result is cast it in a psychological perspective about relative abstinence propensities between poor and wealthier people. Irrespective of methodological loyalties, it is a fact that income can either be spent or it can be saved. Statements about the propensity to consume, are effectively statements about the uses of income (spending vs saving).

Notice we are not saying anything about wealth and related streams of earnings originating from property, titles etc. I guess you could say that a tacit assumption is that poor people own little or no wealth and as such enjoy a single revenue stream which is-for the most part-wages and salaries (and probably whatever net transfers they are entitled to by local, state or federal governments depending on the jurisdiction of their domicile or otherwise).

Another way to see this is by trying to convince yourself that for the most part (and if you don’t include luxury goods like yachts and sport cars etc) in a cross-section of consumption baskets across different levels of income, the value of commodities purchased increases with the income bucket but the rate of increase in bundle price is lower than the rate of increase in incomes. Simply put, poor people spend a larger share of their income for the same range of goods that wealthier people purchase.

Now, one needs to consider a bit what kinds of commodities and services enter the baskets of consumers. There are items like foods and beverages, there’s clothing and shoes, there’s housing and related services eg repair services, there’s also transportation related services and there are fees for education services eg kids in college, fees for insurance services eg retirement plans and medical coverage plans and probably other relevant costs like utilities, municipal fees or whatever applies at different jurisdictions. Generally speaking, the items that cost more in a family or personal budget are those related to institutional services like education, insurance etc.

In more advanced countries, services related to institutional units are tightly integrated in the economic process eg there’s tripartite participation in employee insurance (probably mostly a European thing), medical and retirement plans are usually parceled with remuneration packages (or at least it used to be the case for the majority of the workforce) etc. On the other hand, this is not the case in developing countries in general and China in particular.

A major theme about Chinese economic development is financial repression. This simply means that the Chinese authorities hold interest rates artificially low in order to facilitate economic growth. Low interest rates induce investment but they also allow misallocation of resources, mainly because the financial system in China is highly regulated and subordinate to state objectives. In such an institutional setting, the Chinese people (workers and consumers alike) face a difficult budgeting problem, namely how to allocate their incomes between consumption and saving. Savings need to be abundant enough to cover for medical expenses and retirement because classes of assets that tend to relevant needs are not provided otherwise. The people need to fend for themselves in that regard.

So, in an uncertain environment, consumption is held artificially low, by low interest rates that eventually translate into high propensity to save for the Chinese people (or what is equivalent, low propensity to consume).

If you are interested in all things Chinese I strongly urge you to look up Michael Pettis. I’m convinced his writings will be addressing the bulk of your concerns and even if you don’t agree, for some reason, to his approach, you’ll definitely have a solid argument to grind your teeth against.

Hope any of this helps.

Have a nice one!

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they do NOT spend more as that is impossible

they have a PROPENSITY to spend which is normal as the less money you have the more you have to spend on rent food yada yada

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