Kerala, which gets more than Rs1 trillion in remittances from its emigrants, has an empty state treasury. Despite this large inflow of money, Kerala is one of the least industrialized states in India and has one of the highest unemployment rates in the country. Why?

The quantum of remittances that flowed into Kerala is almost three times the money that flowed into Maharashtra, four times the inflow into Tamil Nadu and almost 10 times the inflow into Gujarat in the form of foreign direct investments. While these states have managed to build a strong, growing economy, why is it that the huge cash flow into Kerala has not turned into productive investments in the state?

According to studies by the Centre for Development Studies, Thiruvananthapuram, conspicuous consumption is the hallmark of a Kerala emigrant. The majority of remittances that flowed into Kerala over the past several decades have only been used to build dead investments like palatial houses and owning depreciating assets like automobiles and consumer goods. Kerala clocks one of the highest sales of luxury cars in the country and is the biggest consumer of gold. Although the profile of the Kerala emigrant has changed over the years, from low-skilled and illiterate to more educated professionals, the tendency to spend their hard-earned salaries on ostentatious living continues.

Behavioural economics could provide an explanation for this sad state of affairs in Kerala.

Professor Richard Thaler of The University of Chicago Booth School of Business put forward the concept of mental accounting to explain how humans deal with money. Mental accounting refers to the tendency of people to separate their money into separate mental accounts based on a variety of subjective criteria, like the source of the money and intent for each account. Unlike what was believed so far, money is not fungible, that is money does not easily move from one mental account to another. The propensity to spend is influenced a great deal by which mental account the money belongs to. So, the money one gets as bonus is spent differently from the money one gets as salary. Or, in other words, the decision on where the money goes or where it is spent depends greatly on where the money comes from.

How does the theory of mental accounting explain the life of a Kerala emigrant?

Let us take the example of nurses from Kerala. Close to 60,000 of them work in places like the US, Europe and the Gulf. The median salary of a nurse in India is about Rs2.5 lakh per year. The median salary of a nurse in the US is about $71,000. The median salaries of nurses in any of these countries comfortably allow them to fit into the middle-class lifestyle of that country.

But the moment an emigrant nurse lands in Kerala, a huge transformation happens. Thanks to currency arbitrage, a salary that would have allowed the person to enjoy the lifestyle of a middle-class household in the country of work, now suddenly gets transformed into an income equivalent to one of the highest-paid professionals in India. This is more like a windfall gain. How does this sudden increase in the perception of one’s income affect one’s spending behaviour?

A 1994 study by Hal R. Arkes, Cynthia A. Joyner and Mark V. Pezzo has shown that people have a greater marginal propensity to consume from windfall earnings than money earned through normal work. Another study in 2009 by John Beshears and Katherine Milkman found that people are more likely to spend windfall money on non-routine purchases. A 2012 study in rural Tanzania by Lei Pan and Luc Christiaensen has shown that money earned through windfall gains is more likely to be spent on non-basic consumption of goods like alcohol and tobacco than basic consumption goods or education. So, it shouldn’t come as a surprise that the windfall gains the Kerala emigrant receives from currency arbitrage are spent on building palatial houses and buying luxurious consumer goods.

Windfall gains normally happen when someone gets an unexpected monetary gain by winning a lottery or getting an unexpected inheritance. Windfall gains are normally transitory in nature. The windfall gains of a migrant Keralite too are transitory. They happen only when he is in India, away from his place of work. Only on those occasions does the mental account look far bigger than normal. Once he goes back to his place of work, he goes back to his normal self.

This insight that where the money goes depends on where the money comes from is a universal insight that guides one’s financial behaviour. It was also found in the behaviours of Indian mutual fund investors and the millions who opened new bank accounts under the Pradhan Mantri Jan-Dhan Yojana (PMJDY).

The government of India is focusing a lot on building a robust infrastructure for direct benefit transfer. No doubt this infrastructure will ensure that the money meant for the poor will no longer be gobbled up by the corrupt middlemen. But this is only half the job done. The government needs to ensure that the money that reaches the poor does not end up in liquor consumption or other wasteful expenditure.

It is here that the learning from the behaviour of the emigrant Keralite—that the source of funds or any perceptions about the source of funds affects one’s spending pattern—holds a lesson for policymakers. How does one frame the source of the money in our direct benefit transfer programme so that the money received goes into the education of the girl child or for buying healthy food for the whole family?

Biju Dominic is the chief executive officer of Final Mile Consulting, a behaviour architecture firm.

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