
September 28, 2009
Commentary
A new look at temptation
Everywhere in the world, people both rich and poor struggle to save and invest for tomorrow rather than splurging on the things they want today. From text messaging reminders, to providing piggy banks, to giving away little motivational presents, IPA investigates ways to help people meet their financial goals and avoid temptation. However, Research Affiliates Abhijit Banerjee and Sendhil Mullainathan have a new paper that suggests we may need to rethink the economics and psychology of temptation.
In the past, economists have offered two basic explanations for why the poor may fail to save or invest as much as they might. The first is that they are simply impatient: consumption today is worth much more to them than consumption tomorrow. The second explanation is that people have inconsistent preferences about consumption over time. For instance, a person might prefer a Snickers bar today over a Snickers tomorrow, but be pretty indifferent between Snickers 20 days from now and 21 days from now – even though both comparisons are between one day and the next. The problem is that when that 20 days from now arrives, 21 days from now becomes tomorrow, and the person reverts to their today vs. tomorrow preferences. We let ourselves get away with indulging today, naively thinking that in the future we’ll be more restrained. In this way, we always save less than our reflective “long-term self” would want.
Either approach – impatience or inconsistent impatience – could explain why we see low savings among the poor. It might also explain willingness to pay for short term loans that finance consumption today at the cost of a very steep interest rate. The problem is that these explanations require that the poor be naturally much more impatient or inconsistent than the rich.
Banerjee and Mullainathan offer a different explanation, one which shows how temptation might interact in a unique way with poverty. Suppose, they argue, that there are certain goods that people are tempted by, such as candy, or coffee, or cigarettes. Then suppose that as people get richer, they spend a decreasing proportion of their income on these goods; not a smaller absolute amount, but a smaller proportion. (There’s only so much money you’re likely to spend on cigarettes, no matter how rich you get.) Finally, suppose you’re realistic enough to know that you’ll be just as tempted in the future by these items as you are today.
In sum, your “long term self” knows that you will spend money on temptation goods in the future, but places no value on that spending. (Your long term self doesn’t like the fact that you’ll spend money on cigarettes, even though your today self wants it.) Knowing that you will spend this money amounts to a “temptation tax” on future wealth. This is a disincentive to save for the future. Why save today? After all, your future self will just squander the money on cigarettes!
But as you get wealthier, the effective “tax rate” is lower, because temptation goods are a smaller proportion of your income. With a lower tax rate, your disincentive to save shrinks. Perversely, if you expect to be wealthier in the future, you have a greater incentive to save and invest! Banerjee and Mullainathan show that this can create a poverty trap. When you expect to be poor in the future, you are less likely to save and invest, which keeps you in poverty. When you expect to be wealthy in the future, you are more likely to save and invest, which makes you wealthier still.
This new model of temptation represents a pretty fundamental shift from the old economic explanations. Rather than assuming that people are inconsistent and naïve about their spending preferences, it assumes that they are foresighted and realistic. The researchers argue that it can explain much of the seemingly myopic behavior we observe among the poor: lack of savings, borrowing again and again at high interest rates, and turning down high return but small investment opportunities. It also offers an explanation that doesn’t rely on the assumption that the poor are inherently different in some way from the rich – they’re just reacting to different circumstances.

What about IPA's reminders projects?
That makes sense, but how does it explain the evidence that reminders and commitment products increase savings? For instance, if you're not saving for the future because you don't like what you would buy, why is receiving a text message saying "Don't forget about the future, remember to save!" likely to make you save more?
So, 2 possibilities: 1) I
So, 2 possibilities:
1) I think savings reminders and commitment savings are not necessarily incompatible with Banerjee and Mullainathan's theory. As for the first, their theory doesn't deal wit other behavioral barriers to saving, like forgetfulness, procrastination on actually travelling to the bank, and so on. Even if your desired level of savings is low for the reasons you describe, reminders could still help people overcome other barriers to achieve desired savings. As for commitment accounts, it's possible that this actually supports their theory: If you can guarantee somehow that your future self won't be able to draw down savings to spend on cigarettes, you might have greater incentive to save.
2) All that said, I'm not sure that I buy the psychology that they need to support their economic model. Does this fit with anyone's actual experience? "Oh, I'll just waste it in the future too, so I might as well waste it now"? Speaking only for myself, I find the "Oh, I can splurge a little now because I'll behave better in the future" train of thought to ring more true. What about you?
As far as I know, you could
As far as I know, you could always close a programmed-savings account (here in Bolivia, you can even keep the interest earned), so there's still no guarantee if you save one month that the next month you won't decide to splurge the next.
In terms of the impact of reminders, I guess that it's one of the examples of shortcomings of RCTs - it's hard to tease out the impact of reminders on different types of people, some of whom are forgetful and are therefore reminded to save more and others who think that they lack discipline and in fact don't look forward to what they're going to get with their savings.
Still, though, both the reminders evidence and focus groups with consistent answers lead me to believe that people tend to save less than they want to.
I definitely have high expectations for future-me. That's probably normal, right?