Poverty and the present bias

It is well documented that people living in material scarcity conditions make different choices from other people. One example of such differences is the behavior in situations of intertemporal choices. A key concept is that of present bias. When subjects have to choose between a benefit at some point in time and a larger benefit later on, the choice does not only depend on the amount of the benefits and the time difference between them, as would be consistent with the value of time consistency, but also on whether the first benefit arrives today or not. For instance, a lot of subjects would prefer receiving €120 in two weeks over €100 in one week, but would prefer receiving €100 today over €120 in a week from now. A vast majority of people exhibit this present bias in all social groups. The present bias (measured by the additional interest rate at which subjects are ready to give up an immediate benefit), however, has been shown to be larger among people living in material scarcity conditions.

Present bias may be an obstacle to escape poverty. Indeed, opportunities to escape poverty may require to consume less today in order to invest in future returns (education, financial, etc.). Poor people with a large present bias may fail to seize opportunities that they may encounter.

The correlation between present bias and material scarcity has received a lot of attention in the economics literature. It raises at least two fundamental questions. First, is the present bias causing poverty, in the sense that people who value the present too much make choices that keep them into scarcity, or does the causal effect go in the opposite direction, that is, living in scarcity influences the choices of people? Second, if scarcity influences choices, that is, in our case, increases the present bias, is it because scarcity changes the way people think about their future and make choices or because poor people rationally adjust to their scarcity environment, especially to the financial liquidity constraints?

A recent contribution by Leandro S. Carvalho, Stephan Meier, and Stephanie W. Wang sheds new light onto these questions [1]. They report the results of the following experiment in the U.S. Starting with a sample of households living with less than $40,000 a year, they randomly assign them into two groups. Then, these two groups are asked to make real monetary and non monetary choices, but households in the first group are asked to make these choices a few days before payday, whereas households in the second group are asked to make these choices just after payday. We can expect the two groups to be identical in all respects except that they have to make choices at different times.

The first choice subjects have to make concern intertemporal budget allocation. They have to divide a budget of $500 into two payments with pre-specified dates, the second of which includes interest. The mailing date of the first payment is either today or in 4 weeks from now, and the time delay between the two payments is either 4 or 8 weeks. Approximately 1 percent of the participants were randomly selected to be paid on the basis of their choices, and all participants knew the true probability.

As expected, subjects from both groups exhibited a present bias. The interesting finding, though, was that subjects from the first group, that is subjects that had not yet received their monthly check, exhibited a larger present bias than the others. Everything else being equal, the possibility of getting money today induces them to allocate a significant additional amount of $10,60 of the budget to the earlier payment compared to the subjects of the other group (subjects, on average, keep $304.3 for the early payment). This suggests that having less financial means deepens the present bias: living in scarcity influences the choices of the people.

Then comes the second question. Why are subjects from the first group exhibiting a deeper present bias? Is it because they rationally adjust to their worsened financial conditions or is it because scarcity influences their way of thinking about the future and taking decisions. The the ability of people to smooth their income across time by borrowing from friends, relatives or institutions and by temporarily dissaving is impossible to measure. So the authors raise this question indirectly.

This is where non monetary choices are at play. Subjects were also asked to make choices about when to perform a required task. They had the choice between performing a short unpleasant task (filling a survey) at a point in time or a longer survey later. Again, there were differences in the length of the surveys, the date of the first survey (today or later) and in the dates of the sooner and the later surveys. Each subject had to make different choices. As for the monetary choices, some subjects were selected to actually perform the tasks, and they knew the probability in advance.

As expected, subjects from both groups exhibit a present bias. That is, they are ready to postpone the survey by one week, even if the survey will be longer one week later, but the length difference is much larger if it is to avoid filling it today than if it is to avoid filling it in four weeks. The more interesting finding here is that both groups behave identically. Facing stronger liquidity constraints does not affect the way people think and make decisions about their future, when their decisions are non monetary. This suggests that the reason why subjects from the first group exhibit a higher present bias when they make monetary choices comes from the liquidity constraints they face in the days before payday and not from the impact of scarcity conditions on their ability to think about the future.

This last finding seems to go against recent contributions insisting on the fact that living in scarcity conditions is in itself a cause of changes in behavior, especially due to a decrease in self-control, with a resulting larger present bias (see, for instance, a previous post entitled “The neurobiological consequences of poverty”). However, the experiment reported by the authors, only measures very short term impact of scarcity conditions, given that what is compared are the choices subjects make just before versus just after receiving their pay check. The absence of such an impact is not in contradiction with long term physiological and psychological effects of scarcity on the way people think about their future.

This paper is of course no more than one contribution on the very difficult question of why we observe this correlation between choices and scarcity. I find it fair to say, though, that this contribution goes once again in the direction that the causal effect goes from material scarcity conditions towards behavior and not the other way around. The channels through which scarcity influences choices are certainly very complex and not fully understood, but this paper clearly shows that very short term liquidity constraints do force poor people to adjust and do increase their present bias in monetary choices.

[1] Leandro S. Carvalho, Stephan Meier, and Stephanie W. Wang ‘Poverty and Economic Decision-Making: Evidence from Changes in Financial Resources at Payday,’ American Economic Review 2016, 106(2): 260–284.

This entry was posted in Uncategorized. Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s