One statement that I find puzzling and a bit unconvincing is this: the poor make suboptimal decisions because they are being constantly cognitively fatigued and more importantly, their mental resources are being depleted to a greater extent than the rich.
Well, first of all, I'm not sure that the poor are being depleted more than the rich. The rich may be depleted by having to think about their business/investment problems which are computationally equivalent to (if not more than) the daily expense problems of the poor. Of course, if you ask the rich to think about their personal finances they will be depleted because it's simply not something that they are used to thinking about.
Secondly, maybe this is a better proof, suppose we strip away the rich's money and bring them to the same level as the poor (much like now) we'd expect the (formerly) rich to display similar behavioral patterns of the poor and be equally cognitively fatigued. If the economy is reviving which group, the formerly rich or the originally poor, will have a better chance to become rich? Certainly the formerly rich. Now, during such process of becoming rich again the formerly rich should be more fatigued than the poor because they not only have to think about their personal finances but strive and fight for any opportunity that will lead to wealth.
Showing posts with label Behavioral Economics. Show all posts
Showing posts with label Behavioral Economics. Show all posts
Sunday, January 25, 2009
What makes the poor poor?
Recently, I got involved in a project of financial scarcity which asks this question: What makes the poor poor? I've always been fascinated by poverty research: growing up in China I witnessed how people started from living with $5 a month and supporting a family to living with $5,000 or more a month over the past 20 years. Of course such a drastic improvement is still not common in most Chinese families but I'm just wondering, while some people have grown out of poverty how come the majority of the poor are still poor not only in China but worldwide?
The story of poverty in China is very different from that in the west. First of all, the barrier that prevents the poor from becoming rich is NOT because they are aversive to banks, or there is no access to financial service providers, or they are impulsive luxury products shoppers, or they have to spend everything just to avoid lending money to relatives who never pay back. The reason that they are sill poor is largely because of the biased policy towards the poor and a lack of monitoring systems that leads to an exploitation of the poor. I don't want to get into the details and instead I want to focus on the poverty in the west.
I think there is one major cause for poverty: the context (the physical, financial, and social environment in which the poor are living). I'm not denying that there are some obvious differences between the poor and the rich: money, resources, education, etc. Of course, there are some individual differences such as myopia and a lack of self-regulation. But the major theme is that the poor are poor NOT because they are intellectually disadvantaged or they are perfectly rational, but the poverty environment in which they are living makes it very difficult (if not impossible) for them to make better choices. If so, then we need to revise our policy and start to create a helpful environment such that the poor can become self-sufficient.
There are several questions that we can address empirically:
1. If we submerge the average or the rich in the context of poverty, will they start to behave just like the poor?
2. If we replenish the poor (e.g. put them in the context of sufficiency), will they start to behave like the average? This suggests a related question which is, is it just the money that the poor lacks or is it a lack of financial literacy or self-regulation, motivation, etc?
3. If we prime the poor certain positive traits, will they start to behave rationally? For example, it has been shown that priming self-affirmation increases the take-up rate of a beneficial financial program. But, is it certain personality traits that we are priming or is it a state of mood or sense of control, etc? We need to disentangle these issues.
4. Will the poor prefer an immediate smaller reward to a long-term bigger reward? Given this task: will you like to receive 50 dollars today or 100 in a year? the average person may show a preference to the latter option. But, the poor might prefer an immediate 50 dollars which allows them to payoff the phone bill this month, or to get food for the family for today.
Having said this, there is one important factor that mediates poverty, which is temptation goods. If a poor person earns $20,000 a year but spends in a mentality of $30,000, he will have to take out loans (possibly with high interest rates, e.g. payday loans). The reason he spends $30,000 is that there are temptation goods everywhere in the environment that lure his wallet. Now, if we endow this person with $50,000 a year, will he spend more or less than $50,000? Maybe he will spend more than he used to and possibly more than $50,000. Now if we constantly endow this person with $50,000 a year for 10 years, will his temptation needs diminish gradually and will he start to build up his savings?
The story of poverty in China is very different from that in the west. First of all, the barrier that prevents the poor from becoming rich is NOT because they are aversive to banks, or there is no access to financial service providers, or they are impulsive luxury products shoppers, or they have to spend everything just to avoid lending money to relatives who never pay back. The reason that they are sill poor is largely because of the biased policy towards the poor and a lack of monitoring systems that leads to an exploitation of the poor. I don't want to get into the details and instead I want to focus on the poverty in the west.
I think there is one major cause for poverty: the context (the physical, financial, and social environment in which the poor are living). I'm not denying that there are some obvious differences between the poor and the rich: money, resources, education, etc. Of course, there are some individual differences such as myopia and a lack of self-regulation. But the major theme is that the poor are poor NOT because they are intellectually disadvantaged or they are perfectly rational, but the poverty environment in which they are living makes it very difficult (if not impossible) for them to make better choices. If so, then we need to revise our policy and start to create a helpful environment such that the poor can become self-sufficient.
There are several questions that we can address empirically:
1. If we submerge the average or the rich in the context of poverty, will they start to behave just like the poor?
2. If we replenish the poor (e.g. put them in the context of sufficiency), will they start to behave like the average? This suggests a related question which is, is it just the money that the poor lacks or is it a lack of financial literacy or self-regulation, motivation, etc?
3. If we prime the poor certain positive traits, will they start to behave rationally? For example, it has been shown that priming self-affirmation increases the take-up rate of a beneficial financial program. But, is it certain personality traits that we are priming or is it a state of mood or sense of control, etc? We need to disentangle these issues.
4. Will the poor prefer an immediate smaller reward to a long-term bigger reward? Given this task: will you like to receive 50 dollars today or 100 in a year? the average person may show a preference to the latter option. But, the poor might prefer an immediate 50 dollars which allows them to payoff the phone bill this month, or to get food for the family for today.
Having said this, there is one important factor that mediates poverty, which is temptation goods. If a poor person earns $20,000 a year but spends in a mentality of $30,000, he will have to take out loans (possibly with high interest rates, e.g. payday loans). The reason he spends $30,000 is that there are temptation goods everywhere in the environment that lure his wallet. Now, if we endow this person with $50,000 a year, will he spend more or less than $50,000? Maybe he will spend more than he used to and possibly more than $50,000. Now if we constantly endow this person with $50,000 a year for 10 years, will his temptation needs diminish gradually and will he start to build up his savings?
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