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.
Here is the core article. For the pointer I thank Rachel Strohm, who tweets about Africa and economic development.
> 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.
there is an explanation in here for the housing bubble as well
I wonder: could the same point be made about public deficits, whereby the role of temptation spending would be taken by social transfers? The idea came to me because I read this post right after an article about France’s exploding public debt.
One word to disprove this: Cocaine.
“Your long term self doesn’t like the fact that you’ll spend money on cigarettes, even though your today self wants it.”
Very Schelling-esque.
Is it true that poor people don’t save? Portfolios of the Poor suggests it’s not.
And it’s not just your future self. One of the problems with wealth creation in Africa is, purportedly, that people know that if they accumulate wealth they will be socially compelled to share with relatives. So they tend not to bother much (and neither do their relatives).
Do you actually believe this is how people think? Do you even know any people?
Do you really think it’s beyond people to think, “Hey, you know, I’m just not very good at saving money. If I have it, sooner or later, I always blow it all. So there’s really no good reason for eating rice and beans for six months to build up savings — I’ve done it before, it’s no fun at all, and I always end back up right back where I started anyway, so what’s the point?”
You’ve posted on this topic before:
http://www.marginalrevolution.com/marginalrevolution/2007/08/the-persistence/comments/page/2/
Pierre-Louis: The difference is that some people like the idea of having Prada boots, even in the abstract. (In fact, some rich-people luxuries might even be more enjoyable in the abstract — things that add a lot of unexpected stress, like a big house.) No one likes having lots of candy and cigarettes in the abstract, only in the here and now.
Ricardo: evidence please.
Comments on this entry are closed.