Poor Decision Making

Universe in 2009 / by Sendhil Mullainathan /

How behavioral economics can help change the fight against poverty.

All too often, the choices of the poor are viewed as a result of either some intrinsic failing (“they’re just very myopic people”) or some deep psychological feature of poverty (“they’re desperate”). Behavioral economics — the integration of psychological insights into economic analysis — offers a third interpretation: All of us face difficulties in making the right choices; the poor are just asked to do it more often and in tougher circumstances.

This perspective will eventually alter the way we fight poverty. It should affect the way in which governments in developing countries set their policies, donor agencies like the World Bank provide aid, and foundations and others give support. In much the same way that the move toward market-oriented policies transformed policymaking, I think a psychologically richer view of poverty will transform both how we understand and how we deal with poverty. As a behavioral economist, I am optimistic that this influence will be for the positive.

Let me illustrate the behavioral economics view through one specific type of behavior: shortsightedness. Among the poor this could include everything from inadequate savings, high-interestrate borrowing (such as through payday loans), or even lack of adherence to lifesaving medications. These problematic behaviors, though, are not so different from the shortsighted decisions and lack of self-control of which we all are guilty.

Please imagine the following scenario. It is Friday afternoon and you are thinking about the slow weekend ahead of you. This, you decide, is the weekend you’ll get your various taxpreparation documents in order. Your returns are due in a few weeks, and you don’t want to be stuck doing taxes in a panic at the last minute, like last year. But as the weekend unfolds, somehow these good motives yield to a Saturday full of little chores and distractions and a Sunday spent relaxing in front of the television. Before you know it, it’s Sunday evening, at which point you decide next weekend is the weekend for doing taxes.

How do we understand shortsighted choices, such as in the tax example? Under the traditional economics view, making choices that have consequences over time is no different from making other choices. Individuals weigh the costs of an action against its benefits. Since the benefits are in the future, people may discount them, but individuals otherwise simply make the cost-benefit calculation and then implement the choice that makes sense. If I am deciding whether to do my taxes, I weigh the pain of today against the benefits of tomorrow. Financial decisions are similar: If I am considering going to a nice meal at a restaurant on my 18 percent APR credit card, I am weighing the pleasure of the meal against the future costs.

Under the behavioral economics view, choices that have consequences over time are different. Looking into the future (“what will I do tomorrow”), individuals may do the same costbenefit calculation as in the traditional view. The difference (and the problem) arises when the future arrives. In the moment of action, individuals can weigh the present far more heavily than they do when contemplating the future. Sitting on the couch and watching TV does not seem very attractive when thinking about tomorrow, but in the moment it is a particularly attractive option. This means that even if individuals would like to behave as the traditional economics view would suggest, they find it difficult to do so. The patient me looking into the future wishes I would do one thing — my taxes this weekend — while the deciding me in the present does another thing — watches TV. This inconsistency is the core difference between the traditional and behavioral views: People can want one thing and do another. A variety of behavioral studies have shown this, by offering hypothetical choices, crafting real choices in lab settings, observing actual choices in natural settings, or more recently in MRI scans of the brain, while subjects made choices with consequences over time. This inconsistency means not just broken plans but a very basic recognition that when we choose we may not always choose what is best for us.

Self-control problems can be consequential for the well-off; examples include failures to eat well, get important medical checkups, or save enough for retirement. But they can be far more consequential for the poor.

In the south of India, for example, sugarcane is a remarkable cash crop. However, in many areas of the region, the very poor farmers use none or very little of their land to plant sugarcane. One of the reasons they cite relates to self-control.

Sugarcane is harvested once a year and paid for in one lump sum. Planting sugarcane, although it’s more profitable monetarily, raises an unappealing psychological challenge. Imagine receiving your entire annual salary all at once, at the beginning of the year, and having to dole it out carefully over the course of 12 months. Meanwhile, many who own cows cite the daily income that milk provides as a primary benefit, even though cows are not as profitable as other investments. This is the far more consequential equivalent of someone purchasing the more expensive (per unit) but smaller bag of cookies to avoid the temptation of eating all of them at once. Uncertainty figures in as well: A small-business owner who does not know what she’ll earn must have the willpower to save in good weeks to ride out the lean weeks, while a salaried worker knows exactly what is coming, and when.

As another example, consider a poor pregnant woman. At the time of delivery, she has a choice between delivering in a hospital, which is costly in the financial sense, or delivering at home, which can be costly in terms of health. In India, for example, 69 percent of women deliver at home, a reason many experts cite as the source of the country’s high maternal mortality rate. In our work, we find that financing the high costs of delivery is a root problem. Many women who do deliver in hospitals are forced to borrow from the local moneylender, who can charge upward of 90 percent interest on the loan, nearly doubling the actual cost of the hospital. Notice the tension here: The same women who borrow at these rates and repay in the months after delivery had known about the impending delivery for six months. Yet they failed to save for it, instead borrowing at usurious rates. Particularly interesting is that because of the interest rates, the borrowers in effect “saved” a lot more: They simply did their “savings” after the fact and at higher cost. For others, the failure to save resulted in an even worse outcome: home delivery and the risk of mortality. This illustrates another consequence of self-control: an inability to save for important investments.

There is a deeper insight in both of these examples. We are accustomed to ensuring that the poor have environments full of opportunities — such as education or access to clean health. But we also need to reconceptualize these environments in terms of how they help the poor to overcome decision challenges. Recognizing that salaried jobs remove one of the most basic self-control problems highlights an additional benefit of formal employment as a poverty-alleviation tool. The recognition that savings generate psychological challenges ought to create a new product-design effort among donors and financial institutions. When pregnant women borrow from a moneylender, they are forced to repay. Saving money, however, has no such structure. So what if we created savings products that had the disciplinary features of debt? This is the challenge that policymakers, donors, and foundations will have to wrestle with.  — Sendhil Mullainathan is a professor of economics at Harvard University.

Originally published February 3, 2009

Tags development economics poverty

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